Tax reform is on the minds of many Republican candidates, and that’s a good thing. Donald Trump revealed a plan, suggesting he may be a serious candidate after all. This announcement came as his poll numbers were slipping, so we may have a hint what voters think about actual policies. Jeb Bush released his plan earlier this month with the distinction of being called “weird”.
The point is that we are talking about taxes and serious tax reform, which is good. No one should expect one plan to suddenly spring forward and cut through the elaborate mess we have. Then again, once the knife is out, you could carve a better tax code out of a banana. But what really is needed? What is “simplification” or “reform”? Let’s start at the beginning.
Calls for tax simplification date back about as far as taxes themselves. Income tax has always been complicated for one very simple reason – it taxes income. What is income? Usually, we actually mean “profits” in the broadest sense, which is really income after expenses needed to realize that income, which has always been deductable. So right from the start we have a tremendous amount of confusion about what we’re actually talking about.
“Simplification” itself is a strange concept in practice as well. It generally means a net reduction in the number of rate brackets. This is a very silly thing to dwell on because it hardly matters to anyone at all. Hours are spent defining income and expenses to get profit and with the push of button any decent piece of tax software will tell you what you owe regardless of what “bracket” you are in.
It may be that people make decisions about what to buy based on their bracket, but this presumes everyone is perfectly rational and knows exactly where they are tax-bracket wise. Generally, people don’t worry about brackets around April 15 as much as they do in March when the NCAA tourney is on.
Tax reform is difficult and elusive, so let’s not presume that a big program is needed to tackle it.
Let’s start with what we have and work towards something better. We need a system that is progressive, which is to say raises more money from those who benefit from society the most, and has systemic reform built into it. Real simplification has to get to the heart of a successful tax code, which is to say one which raises the amount of money needed and is generally perceived as “fair”. Beyond that? Whatever.
How much money is needed? The Feds take in $1.4 trillion in income tax, which is 46% of receipts. The perceived “fairness” of it, however, is another question. A majority of Americans do think the amount they pay is “fair”, which is not bad. Perceptions of “fairness” depend on more than the level of taxes anyone pays – there is also the issue of what everyone else is paying. The idea that business don’t pay their “fair share” bothers 64% of taxpayers “a lot” and the feeling that the wealthy don’t pay their fair share bothers 61% “a lot”.
Complexity, as a concept, only bothers 44% “a lot” by comparison.
Given that we spend an estimated $234 billion figuring out all taxes (individual and corporate) we do indeed have a very complex system. That’s about $2,000 per household just for “compliance”. This figure doesn’t apparently bother people as much as the perception that someone is getting away with not paying what they should, meaning that when tackling complexity, compliance cost is more of a problem than compliance perception.
Given this, the path ahead should be obvious. Tax Reform means eliminating special exemptions and deductions against income that appear to apply narrowly to only some people or business. So how do we tackle this?
Simple. Give up on the big programs and proposals and just do something.
Why not start with a simple formula – plot every possible deduction against how many people actually take it. We should quickly see what the least popular of all deductions are, which is to say those that benefit only a special interest. Exactly which ones to get rid of and where to draw the line should become obvious once we know how popular any deduction is and what it “costs” the government in revenue.
The Result? A better tax code that raises just a bit more money while affecting the smallest number of people.
Systems like this depend on a functioning Congress, of course, and are not something that a new President can boldly take credit for. Then again, reform work is really rather dull when it’s done well. That’s the lesson the Presidential candidates are getting about now and perhaps they should heed it. In broad terms, it’s good, but in details? A snooze.