April 15 May Get Less Taxing if Debt Cutters Have Their Way
I should be doing my taxes, but instead I’m writing this column. When I’m done with that, maybe I’ll do some ironing. I’d do anything to postpone tax filing. It’s just so darn complicated!
Ironically, perhaps, I’m something of a tax expert. I was a top tax official in President Clinton’s Treasury Department and cofounded the Tax Policy Center in Washington. Because of that experience, I know that my misery is completely avoidable.
At Treasury, every time the famously empathic President Clinton felt someone’s pain, staff proposed a new tax credit or deduction to alleviate it. Never mind that the argument for government intervention was often dubious and the case for doing it through the tax code even weaker, politicians like to give away goodies. But they make things really complicated.
It’s a bipartisan problem. Politicians of all stripes can’t resist creating tax subsidies to reward and “incentivize” behavior. To keep people from exploiting those rewards and incentives to pay embarrassingly little tax, however, the code takes back some of the tax breaks with a variety of phase-outs (meaning you lose the goodies as your income grows). Thus, tax complexity multiplies like a virus.
The poster child for mind-numbing complexity is the alternative minimum tax. It makes you figure your tax under a completely different set of rules and rate schedule and, if that amount is higher than your regular tax, pay the difference as AMT. Originally intended to make millionaires pay at least a little tax, it has mutated into the bane of the middle class. It hits New Yorkers especially hard because deductions for our super-sized state and local taxes are not allowed under the AMT.
The tax code also includes baffling multiple choice tests. For example, taxpayers must choose among three subsidies for college tuition: the lifetime learning tax credit, the American opportunity tax credit, and the deduction for higher education expenses. (The deduction was championed by our own Senator Schumer, who thought that two tuition tax breaks were not enough for New Yorkers.) If you can figure out which one is right for you, you probably already have a Ph.D.
But before you jump out the window (or resort to ironing), there’s hope. Efforts currently underway to tame our ballooning national debt all include a healthy dose of tax reform. The president himself made an eloquent call for reform on Wednesday: “I’m calling on Congress to reform our individual tax code so that it is fair and simple – so that the amount of taxes you pay isn’t determined by what kind of accountant you can afford.”
The silver lining behind our looming debt catastrophe is that many of the tax subsidies that complicate April also cost the Treasury a lot of money. Eliminating them could be a twofer—simplifying tax compliance and reducing the debt. All but one of the major debt reduction proposals would slash tax subsidies and use the savings to pay for lower tax rates and smaller deficits. Besides for simplifying, this also makes the economy work better because a tax system with fewer loopholes and lower tax rates is much less conducive to inefficient tax shelters.
The exception is the recent proposal by House Budget Committee Chairman Paul Ryan. Like the president’s plan, it’s completely noncommittal on which tax subsidies will fall under the axe. But it’s quite clear that all the savings—$3 trillion according to the Tax Policy Center—would be spent on lower tax rates for individuals and corporations. In another time, this kind of “revenue neutral” reform might have made sense, but I think Congressman Ryan underestimates the challenge in closing our giant debt hole. He is one of very few people who think that it can, or should, be filled by spending cuts alone.
The best model, in my view, is the plan proposed by the Domenici-Rivlin task force, on which I served. The plan (details at bipartisanpolicy.org) would raise revenue, cut tax rates, help pay down the debt, and simplify the tax system so much that half of Americans would no longer have to file tax returns. That is change we could all believe in.
The debt is an urgent problem and I cheer on the would-be reformers. Yeah, we’ll probably end up paying more taxes down the road, but with a smaller mountain of debt to pay back, our kids will pay less. And maybe our kids won’t be pulling out their hair on future April 15s trying to decode our Rubik’s Cube tax system.
Len Burman is an affiliated scholar at the Urban Institute and the Daniel Patrick Moynihan Professor of Public Affairs at the Maxwell School of Syracuse University.
[This was originally published in the Syracuse Post-Standard.]
If mortgage interest is no longer deductible, it will kill the second mortgage industry, as people will no longer cash out their equity. This is probably a good thing.
Len, although I share your aversion to phase-outs, my reason is not their complexity. It’s that they are sneaky. The success of our tax system depends on persuading taxpayers to report their income and deductions accurately. Sneaky laws set exactly the wrong example. When the government claws back advertised benefits, taxpayers are tempted to claw back their tax liability in equally shady ways.
On the other hand, one might argue that income tax liability is so inscrutable that any one sneaky provision is effectively invisible to non-expert taxpayers. According to that argument, the forest of sneaky provisions hides each individual provision. This argument is not persuasive when debating comprehensive elimination of all sneaky provisions.
Sneaky tax law exists because it improves election prospects for legislators that enact it. I don’t foresee that cause and effect changing. Tax software providers have some of the world’s safest jobs.
The AMT is the ultimate clawback – and it probably should be.
Let’s understand why the tax system is the way it is today.
Think about a house. The house was originally a 2 bedroom one bath house. Soon the owners wanted a third bedroom, so it was added on. Then they wanted another bathroom, but it didn’t fit well, but they added it anyway. Then the kitchen needed to be increased and re-done, and that had to be wedged in. Afterwards a new family room with fireplace was added, not where it would have gone had it been in the house from the beginning, but where it would fit on the property.
This process continued, so that decades later the house was a monstrosity. It was very expensive, very big, but nothing fit right, nothing worked right and it was a terrible house. However, each individual decision was the right decision at the time it was made, but collectively the decisions were a disaster. The ideal solution would be to tear down the house and rebuild it, but today over $1 million is invested in the house and it is just not practical or financially feasible to tear it down and start over.
The current income tax system is analogous to this house. It started out simple, and over time changes were made for specific provisions. Each change had a purpose and was justifiable as an individual act, but in the end we ended up with a tax system that is the monstrosity that Mr. Burman and everyone else complains about. Even worse, the policy of the last several years has been to make temporary changes that may or may not be extended. This has been an even greater disaster since a fixed tax system that is relatively complex and inefficient is preferable for economic growth to a tax system that is simpler and more efficient but is changing every year.
Some people have proposed tearing it down and starting over, with a VAT or a BRT for example, but this is not practical (politically). However good an idea these things may be, they are not going to happen because they cannot happen. As a result, we are left with doing in the future what we have done in the past, making additions to the edifice in order to try to correct the mistakes of the past. Consequently, if no changes are made we will have a very complex tax system. If changes are made for simplification, we will have an even more complex system.
Like the house in the example above that is so complex and ill-designed that even a small change is difficult and expensive, our tax system is at the point where even small changes are difficult and almost impossible to make. Reforming the tax system is like peace in the middle east. Everyone is for it, it seems necessary and logical and yet it never happens. The reasons a peace settlement in the middle east and tax reform will not happen is that while everyone is for these things in principle, there is no majority for it when the details are proposed. Hence one thing Obama and Ryan have in common is that both are unwilling to set forth the specific changes they would enact.
A large part of the problem is the citizens have been told that they can have all these great government services, but not have to pay for them. For decades they were told that tax cuts pay for themselves, and now everyone, except for Mr. Ryan, knows that is not the case. However, that does not mean the fantasy of the free lunch is gone, denial has nicely taken care of keeping that dream alive.
The conclusion, don’t put that iron away any time soon.
The best model would be a hybrid between Lawrence Lindsey’s Business Receipts Tax and the Michael Graetz’s VAT, with a few of Len’s elements thrown in to focus the BRT on health care and the distribution of the child tax credit (which should be enlarged by the amount that the deductions for home mortgage interest and property taxes are reduced).
The Rivlin-Domenici plans insists that, even though most Americans need no longer file, they be sensitized to how much their employers pay in tax on their behalf. I would much rather make consumers the object of taxes to fund discretionary spending and employers the object of taxes to fund education, income redistribution and health care – giving them the option of paying less tax for providing more direct services rather than having government provide them.