As tax day passes us by there has been a lot of talk about reforming the U.S. tax code. Everybody seems to be in favor of it, but nothing seems to happen. People talk about how difficult it will be because so many special interests have a stake in some part of the code, but the truth is that reform is easy with the political will. As long as it is agreed that all special interests tax breaks are to be removed then if legislators stand firm the special interests can be defeated. I mean no one is going to lose re-election for voting to drastically simplify the tax code.The real issue is that politicians try to sneak in policy changes in the name of tax reform. The talk about how there reform will simplify the tax code, but really it is designed to lower someone's rates, or raise revenue or sound like it does both while doing neither. So lets look at some of the lies told about tax reform.
First, fewer tax brackets are better. This is utter nonsense. The number of tax brackets does not make the tax code complex. If there are two or two hundred brackets, your calculate your income and then look up how much you owe. Because a tax table would take up more space on a page it is complex? Ridiculous! Also having too few tax brackets causes a real problem in peoples behavior. Too few brackets, like Ryan's proposed 8% and 25% brackets mean that people see a drastic tax rate increase at a certain income level. This incentives behavior to keep one's income just below the change in rates. This is exactly the kind of behavior that economist argue the complex tax code creates and why a simpler tax code is a better use of the nations resources. The real reason people propose fewer tax brackets is so that the highest bracket includes more people. If only millionaires have to pay a higher rate, then only a small percentage of the country is effected. If everyone making 50,000 and above has to pay the same rate, then suddenly many many people are effected by rate changes. Reducing the number of tax brackets means more people pay the same rate as billionaires and thus are more likely to want to keep those rates low. This has everything to do about keeping tax rates low for the very rich and nothing to do with simplifying the code.
An even more egregious version of this is the flat tax, which is usually defended because of its simplicity. Again tax brackets are not complicated. You print a page of numbers and that is all. Web sites can easily be designed where you enter your income and it gives you your rate and the amount you owe and for those who don't like the internet the same thing can be done by phone. You can argue that you don't like a progressive tax rate, but that argument has nothing to do with simplicity.
Having said all this, I must mention that tax brackets themselves are stupid. A progressive tax rate should simply increment as a function of income so that there are no jumps in the rates. This also elements the constant political maneuvering of setting the range and rate of each bracket. Instead the tax rate is just set by a few quantities. For example, a sensible system would be to set the lowest rate for a person working full time at the minimum wage, currently $7.25 an hour. So 40 hours a week and 50 weeks a year this person earns $14,500 annually. Someone making 50 times this amount or $725,000 annually to me seems to be very well off and should pay the top rate. So you just set the lowest and highest rates for these values and then have a function to get from one to the other and you are done. Also, make the values in terms of the minimum wage, that way they move with inflation.
The other big lie in tax reform is that deductions can be eliminated leading to a great increase in revenue. Its true if all deductions were eliminated then that would greatly increase revenue, but the reason it would increase revenue so much is because of the few deductions that most people claim. The tax deductions for employee health care, mortgage interest, retirement tax breaks, the earned income tax credit and charitable contributions. Without eliminating those five deductions some extra revenue could and should be raised, but nothing like the numbers promised. Politically though this isn't going to happen because the majority of people make use of those deductions and it is not unreasonable to encourage these beneficial behaviors.
The big lie here though is that while it is good to encourage people to have healthcare, own homes, save for retirement, work and give charity there is no reason for that incentive to keep increasing for the most well off. Millionaires are going to own a home, have healthcare and save for retirement regardless of the massive tax breaks they get for these things from the current tax code (they may or may not give charity). The simple solution is to cap that amount that can be taken for a deduction for these items (I would exclude charity from this cap) and make it clear that the cap will not be raised in the future. This way the incentives are still there and most Americans continue to enjoy these tax breaks, but the richest get a smaller break raising more revenue and reducing the economic distortions caused by the breaks. Keeping the cap fixed for the future makes these tax expenditures smaller and smaller over time.
Thus tax reform is actually quite easy, get rid of everything except the five largest tax breaks, cap the amount that can be taken for those and get rid of tax brackets all together replacing them with a sliding scale. Besides making it easier for everyone to calculate their income taxes, raising more revenue, reducing rates or a combination of both and ending economic distortions, simplifying tax code means at least in one area there is no reason for special interest to try and bribe politicians for tax favors.
First, fewer tax brackets are better. This is utter nonsense. The number of tax brackets does not make the tax code complex. If there are two or two hundred brackets, your calculate your income and then look up how much you owe. Because a tax table would take up more space on a page it is complex? Ridiculous! Also having too few tax brackets causes a real problem in peoples behavior. Too few brackets, like Ryan's proposed 8% and 25% brackets mean that people see a drastic tax rate increase at a certain income level. This incentives behavior to keep one's income just below the change in rates. This is exactly the kind of behavior that economist argue the complex tax code creates and why a simpler tax code is a better use of the nations resources. The real reason people propose fewer tax brackets is so that the highest bracket includes more people. If only millionaires have to pay a higher rate, then only a small percentage of the country is effected. If everyone making 50,000 and above has to pay the same rate, then suddenly many many people are effected by rate changes. Reducing the number of tax brackets means more people pay the same rate as billionaires and thus are more likely to want to keep those rates low. This has everything to do about keeping tax rates low for the very rich and nothing to do with simplifying the code.
An even more egregious version of this is the flat tax, which is usually defended because of its simplicity. Again tax brackets are not complicated. You print a page of numbers and that is all. Web sites can easily be designed where you enter your income and it gives you your rate and the amount you owe and for those who don't like the internet the same thing can be done by phone. You can argue that you don't like a progressive tax rate, but that argument has nothing to do with simplicity.
Having said all this, I must mention that tax brackets themselves are stupid. A progressive tax rate should simply increment as a function of income so that there are no jumps in the rates. This also elements the constant political maneuvering of setting the range and rate of each bracket. Instead the tax rate is just set by a few quantities. For example, a sensible system would be to set the lowest rate for a person working full time at the minimum wage, currently $7.25 an hour. So 40 hours a week and 50 weeks a year this person earns $14,500 annually. Someone making 50 times this amount or $725,000 annually to me seems to be very well off and should pay the top rate. So you just set the lowest and highest rates for these values and then have a function to get from one to the other and you are done. Also, make the values in terms of the minimum wage, that way they move with inflation.
The other big lie in tax reform is that deductions can be eliminated leading to a great increase in revenue. Its true if all deductions were eliminated then that would greatly increase revenue, but the reason it would increase revenue so much is because of the few deductions that most people claim. The tax deductions for employee health care, mortgage interest, retirement tax breaks, the earned income tax credit and charitable contributions. Without eliminating those five deductions some extra revenue could and should be raised, but nothing like the numbers promised. Politically though this isn't going to happen because the majority of people make use of those deductions and it is not unreasonable to encourage these beneficial behaviors.
The big lie here though is that while it is good to encourage people to have healthcare, own homes, save for retirement, work and give charity there is no reason for that incentive to keep increasing for the most well off. Millionaires are going to own a home, have healthcare and save for retirement regardless of the massive tax breaks they get for these things from the current tax code (they may or may not give charity). The simple solution is to cap that amount that can be taken for a deduction for these items (I would exclude charity from this cap) and make it clear that the cap will not be raised in the future. This way the incentives are still there and most Americans continue to enjoy these tax breaks, but the richest get a smaller break raising more revenue and reducing the economic distortions caused by the breaks. Keeping the cap fixed for the future makes these tax expenditures smaller and smaller over time.
Thus tax reform is actually quite easy, get rid of everything except the five largest tax breaks, cap the amount that can be taken for those and get rid of tax brackets all together replacing them with a sliding scale. Besides making it easier for everyone to calculate their income taxes, raising more revenue, reducing rates or a combination of both and ending economic distortions, simplifying tax code means at least in one area there is no reason for special interest to try and bribe politicians for tax favors.
