The Tax Tax

Tax Forms

Every year, the average household pays the equivalent of college tuition to the federal government, not counting state, local and sales taxes. To the extent that government activity does not return the same or greater value to citizens, these taxes are a drag on the U.S. economy. But a closer look unveils additional costs hidden beyond the books, which further call into question the wisdom of our current tax arrangement.

There are many ways to tax a population: on goods, on services, on income or on the basis of mere citizenship (as the Affordable Care Act does unless one purchases health insurance). Each of these comes with drawbacks, because they either discourage economic activity or disproportionately burden certain people.

Enter tax credits and deductions. These are designed to relieve some of the pains of this necessary evil, but have in many ways become a new evil themselves.

The first federal income tax applied to only three percent of households, and was created to support the Civil War. Rather than dissolving after the war, it became a useful tool that demanded larger contributions from a larger base of people. Facing constitutional challenges, the income tax was made permanent and unrestricted by the 16th Amendment. As Americans have campaigned and lobbied for benefits to certain groups over the last century, today’s tax code has ballooned to 73,954 pages of favors and pitfalls. In a 2003 article by Chris Edwards of the Cato Institute, he writes:

As the income tax grows more complex, the number of IRS tax forms has jumped from 402 in 1990 to 526 by 2002. Congress hands the accountants business on a silver platter when they create special interest tax forms such as “8845-Indian Employment Credit” and “8834-Qualified Electric Vehicle Credit.” When Congress penalizes an activity, we get tax forms such as “6197-Gas Guzzler Tax.”

That was ten years ago, and Washington has continued to build new layers upon the old. Recent research by the Mercatus Center found 4,428 changes to the tax code between 2001 and 2010.

Under such a complex code, those who can afford to do so hire experts, and those who cannot do the best they can to navigate the obstacle course with a hope and prayer. Businesses must pour resources into new staff, or outsource the task, in order to avoid serious legal trouble.

We might call it the tax tax: all of the precious time and money that is drained out of the economy—out of our livelihood—and into compliance costs.

“Each year 6.1 billion hours are spent complying with the tax code,” writes Washington Post columnist George Will. “That is equal to the work time of 3 million full-time workers, making tax compliance one of America’s largest industries.” The Mercatus study says this represents “a workforce equivalent to that employed by the four largest US companies—Walmart, IBM, McDonald’s and Target—combined.” This doesn’t include the more than 90,000 IRS employees who are literally working on tax compliance and processing year-round.

If the federal government wants to create jobs, this is a very strange way to go about it. With so many other needs in society, it seems a rather huge waste to have the equivalent of 3 million people working hard at what amounts to zero added value.

Equally disturbing is the immeasurable impact of the unseen: How many would-be entrepreneurs never take the steps to start a company because they cannot surmount the tremendous legal responsibilities of compliance? How many small businesses have failed only because such costs chipped away at their bottom line?

     A cleaner, fairer and flatter tax code would help pave the way to a stronger economy and a more free society.

To solve the problem, we must address the absurd complexity of the tax code. Yet we continue to move in the wrong direction: In 2011, there were 173 different deductions and credits, called “tax preferences,” and this year, the number of tax brackets increased from 24 to 28, with a top rate of 39.6 percent.

Unfortunately, simplifying the code is itself a complex task, not because there aren’t enough ideas, but because there are so many. In order to reform anything there must be broad agreement, but every change to the code alters the benefits equation for one group or another.

Alterations must be balanced in order for any bill to be politically viable. The elimination of tax preferences cannot be, well… preferential; indeed, they may have to be universal—a bipartisan “clean slate” approach, as suggested recently by Senators Max Baucus (D-Mont.) and Orrin Hatch (R-Utah). There is resistance to such a proposal even among many conservatives, who would like to see such benefits as the mortgage interest deduction and child tax credit remain in force. These are intended to encourage activity that conservatives understand to be healthy. But if this reasoning is enough, it would seem liberal policymakers are equally justified in making their own demands toward behavioral preferences. Thus, the all-or-nothing deal proposed.

In the event that congress can manage to cooperate on such a proposal, the door would be open for a reduction in overall rates. However, there remain substantial challenges ahead for advocates of a flatter rate structure. Americans do not easily stomach higher rates on average or below-average incomes, or lower rates on high incomes.

A cleaner, fairer and flatter tax code would help pave the way to a stronger economy and a more free society. We must tame the tax leviathan to allow individuals and businesses to focus on more valuable goals, rather than becoming entangled in the web of compliance.

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