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Tax Reform and the difficulties of simplification [Long OP]
spacekungfuman
Poor and minority-filledRegistered User, __BANNED USERS regular
Poor and minority-filledRegistered User, __BANNED USERS regular
I know there are other threads this discussion could go in, but I think the topic of tax simplification is important enough to warrant its own discussion separate from discussion of income inequality or the campaign process.
In looking over these forums, I have seen a number of people arguing that one clear way to improve America would be tax reform and simplification. As a corporate tax and employee benefits attorney in private practice at a major US law firm who recently completed pro bono work on a draft federal tax credit for certain low income individuals, I just wanted to make it clear how difficult that simplification can be. This is not intended to be a discussion about whether or not tax simplification should occur; instead I want to focus on why it is so difficult to accomplish it.
For purposes of this discussion, I will assume that someone in favor of tax simplification (i) generally supports uniform effective tax rates for similarly situated people (i.e., that people earning similar incomes should pay taxes at the same rate, instead of being able to lower their effective rates through credits and structuring) and (ii) is not concerned with the (extremely complex) transition issues in going from the current tax system to a new system.
If we stick with an income tax like the current federal tax system, the first issue that we face is defining income. While this might seem simple (just look at what people earn or receive) there are a number of key questions that we face, such as if people should be taxed on cash or cash plus property (including the receipt of non-cash services such as employer provided healthcare). If we answer by saying we will only tax cash, then people who can afford to be less liquid will take compensation as property. If we say that both cash and property should be taxed, then we may require people to sell property they would not have or to decline things like health care, to afford to pay their taxes. There are countless other questions around the definition of income, but this should illustrate that there is no easy answer.
Questions like the above are not easy to answer, but they are also not impossible. But my sense is that when people talk about tax simplification, they are largely concerned with the benefits that corporations and high income individuals get through tax “loopholes.” While there are certainly some sections of the tax code that seem to fit this description (such as so-called rifleshot provisions which are only intended to apply to a single taxpayer in a single year), a lot of these “loopholes” actually serve important purposes. For example, people often say there is abuse around the like-kind exchange rules (rules which allow two taxpayers to exchange similar property without paying tax until they sell the property they receive) and while abuse is possible, without the rules there would be no way for these exchanges to happen, since both parties would have to sell the property they exchange to cover their taxes. A more fundamental and important “loophole” is the section of the code allowing for tax free reorganizations of businesses. Without tax free reorganizations, companies would not be able to change their corporate form or merge with other companies without triggering extremely high tax bills. On the one hand, these rules are enormously complex, and navigating them in connection with a single merger or acquisition costs tens or hundreds of thousands of dollars in legal and accounting fees. But if we did not have these complex rules in our simplified tax code, then the tax consequences of these deals would distort the market, and cause countless deals which are sensible apart from taxes to be irrational.
A more fulsome discussion of the tax code or tax policy is beyond the scope of a forum thread, but I wanted to illustrate some of the complexities in tax simplification. The code is complicated (the code plus regulations literally takes up a full shelf in my office) but that complexity arose in response to questions that arose in trying to apply the tax code to circumstances that the original authors could not foresee. This does not mean that the code cannot be simplified, but I think it is important to realize that realistic simplification would most likely mean that I would reclaim half a shelf in my office, and some people would pay more in taxes. Expecting more than that (and every tax reform in US history has mostly resulted in changing some sections, while retaining and renumbering most of the code that existed prior to reform) is just not realistic in my opinion, regardless of what any politician or pundit who does not understand how the tax code operates may say.
I'm not sure how much time I will have to participate in any discussion that takes place, but I will be happy to answer any questions people have about the realities of the tax code and tax policy, and to weigh in on the technical meaning of any of the simplification proposals that have been bandied about. Thanks for reading!
Edit: Deleted reference to consumption tax. This is a thread about tax simplification, not the merits of a consumption tax vs an income tax.
In looking over these forums, I have seen a number of people arguing that one clear way to improve America would be tax reform and simplification. As a corporate tax and employee benefits attorney in private practice at a major US law firm who recently completed pro bono work on a draft federal tax credit for certain low income individuals, I just wanted to make it clear how difficult that simplification can be. This is not intended to be a discussion about whether or not tax simplification should occur; instead I want to focus on why it is so difficult to accomplish it.
For purposes of this discussion, I will assume that someone in favor of tax simplification (i) generally supports uniform effective tax rates for similarly situated people (i.e., that people earning similar incomes should pay taxes at the same rate, instead of being able to lower their effective rates through credits and structuring) and (ii) is not concerned with the (extremely complex) transition issues in going from the current tax system to a new system.
If we stick with an income tax like the current federal tax system, the first issue that we face is defining income. While this might seem simple (just look at what people earn or receive) there are a number of key questions that we face, such as if people should be taxed on cash or cash plus property (including the receipt of non-cash services such as employer provided healthcare). If we answer by saying we will only tax cash, then people who can afford to be less liquid will take compensation as property. If we say that both cash and property should be taxed, then we may require people to sell property they would not have or to decline things like health care, to afford to pay their taxes. There are countless other questions around the definition of income, but this should illustrate that there is no easy answer.
Questions like the above are not easy to answer, but they are also not impossible. But my sense is that when people talk about tax simplification, they are largely concerned with the benefits that corporations and high income individuals get through tax “loopholes.” While there are certainly some sections of the tax code that seem to fit this description (such as so-called rifleshot provisions which are only intended to apply to a single taxpayer in a single year), a lot of these “loopholes” actually serve important purposes. For example, people often say there is abuse around the like-kind exchange rules (rules which allow two taxpayers to exchange similar property without paying tax until they sell the property they receive) and while abuse is possible, without the rules there would be no way for these exchanges to happen, since both parties would have to sell the property they exchange to cover their taxes. A more fundamental and important “loophole” is the section of the code allowing for tax free reorganizations of businesses. Without tax free reorganizations, companies would not be able to change their corporate form or merge with other companies without triggering extremely high tax bills. On the one hand, these rules are enormously complex, and navigating them in connection with a single merger or acquisition costs tens or hundreds of thousands of dollars in legal and accounting fees. But if we did not have these complex rules in our simplified tax code, then the tax consequences of these deals would distort the market, and cause countless deals which are sensible apart from taxes to be irrational.
A more fulsome discussion of the tax code or tax policy is beyond the scope of a forum thread, but I wanted to illustrate some of the complexities in tax simplification. The code is complicated (the code plus regulations literally takes up a full shelf in my office) but that complexity arose in response to questions that arose in trying to apply the tax code to circumstances that the original authors could not foresee. This does not mean that the code cannot be simplified, but I think it is important to realize that realistic simplification would most likely mean that I would reclaim half a shelf in my office, and some people would pay more in taxes. Expecting more than that (and every tax reform in US history has mostly resulted in changing some sections, while retaining and renumbering most of the code that existed prior to reform) is just not realistic in my opinion, regardless of what any politician or pundit who does not understand how the tax code operates may say.
I'm not sure how much time I will have to participate in any discussion that takes place, but I will be happy to answer any questions people have about the realities of the tax code and tax policy, and to weigh in on the technical meaning of any of the simplification proposals that have been bandied about. Thanks for reading!
Edit: Deleted reference to consumption tax. This is a thread about tax simplification, not the merits of a consumption tax vs an income tax.
spacekungfuman on
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Think Pepsi vs Store brand.
If anything sales tax should be completely eliminated and property and income/investment taxes should be adjusted accordingly. You'll probably see an increase in revenue this way, because there's more money in play.
It was my assumption they do, but I'd like to see if it's been documented.
Even if we went to an idiotic one sentence flat tax policy the code would not stay simple if we insist on using tax policy as the primary form of implementation for policy.
I actually was hoping to discuss simplificaiton, not the merits of a consumption tax vs an income tax (which is a completely seperate and extremely complex question). I have edited to OP to reflect the focus of the thread.
Without going into much detail, a consumption tax with a large exemption (i.e., no tax on the first $20-50k in consumption for the year) has gained widespread support among academics for a number or reasons, including the fact that it encourages saving, and saving is positively correlated with economic growth. A consumption tax also lowers certain barriers to the efficient movement of money which exist under an income tax (i.e., if you are invested in a company and see that there is another company you'd rather invest in, you may choose not to move your money due to the tax hit for selling your stock in the original company).
I think everything you have said is true, but I think its imortant to remember that even if you did not want to build social policies into the code, you would still need to introduce complexities like the ones I mentioned in the OP to avoid distorting behavior through the code.
The consumption tax people agree on because on it's face it appears more fair because in theory it is. It provides you with the freedom to chose to be taxed or not to be taxed. But that ignores the greater question of what the actual purpose of taxation is in any sort of a government. Which, let's face it, any and all government spending is redistribution of wealth. Either upwards redistribution through military-industrial and prison-industrial spending and tax cuts, or downwards redistribution through social services, graduated income taxation, etc.
So you can't even talk about tax restructuring without first agreeing on what your goals of taxation are to begin with. In my own humble opinion I want taxation and government to act as a guarantor of fundamental fairness in all things and that means that it needs to curb certain excesses so I find the idea of progressive income taxation (with income defined as both direct cash income earned as well as any and all income earned via interest, if you tax income and interest as one unit then you prevent investments from escaping taxation) far more preferable. I'd rather we actually just got rid of loopholes all together and offset the closure of loopholes with direct spending in other areas.
Historically tax incentives have proven to only motivate mega-corporations and wealthy individuals to contribute less to the tax base and that while it does produce some ancillary good behavior by and large it robs us of the revenue we need to seriously attack problems like poverty and proper regulation of certain industries. I'd rather that each year we adjust progressive taxation on an ad hoc approach each year based on the economy, to allow the tax policy to reflect the state of the economy and also to enable it to work for economic recovery versus against it, then also tweak spending levels each year similarly.
How do you possibly implement that. Who is going to keep track of how much I've spent in a year?
At best you add in subsidies for rebates like the EIC and rebate back money at the end of the year (that will just get taxed again as they try to make ends meet) and at best you end up with a taxation system that is burdened by the middle class and casually ignored by the wealthy. And the tax you'd draw in would be marginal as now you've gotta update tax laws and enforce it.
Income and investment taxes would be a much better target, and you'd see a much better outcome too. You've already got the infrastructure in place, all you're doing is upping a percentage.
Again, I was hoping to discuss simplification, which is a different topic than what form of tax system we should have. But the thinking is that if you make the exemption high enough to cover neccesities (the most commonly bandied about exemption i between $15-50k), then even poor families will have the ability to save, which is the only way that a poor family can effectively break out of poverty. It also keeps the tax from being regressive.
The capital gains rate is low for long-term capital gains, but it is still not 0%, so it acts as a barrier to the efficient movement of money. Also, don't forget that if you hold stock for less than 1 year, you pay tax at ordinary income rates.
That seems pointless, you might as well just raise income tax and be done with it.
I respectfully disagree with your assertion that the income tax exists as a brake on income inequality. The current tax brackets are among the flatest in US history, and due to the low long-term capital gains rates, the wealthy actually pay less on the bulk of their income than the poor (at least among those of the poor who pay taxes). I think that the income tax is our dominant tax as a matter of historic accident. Most of the world has moved to primarily using consumption taxes, such as a VAT.
As far as what taxation should be about, that is obviously an incredibly broad topic which I do not think we could make any meaningful progress on through discussion on an internet forum, since it is so subjective. The only thing that I will say is that any tax can be designed to raise a targetted amount of revenue, and we could easily replace the US income tax with a consumption tax on a revenue neutral or revenue positive basis.
That's fine. But assuming we stay with an income tax system (which is one of the assumptions the OP is explicitly based on) how do you feel about the difficulties in keeping that tax rate relatively "uniform" among similiarly situated tax payers?
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Actually, you are thinking of a deduction. Exemptions are dollar for dollar, and are unaffected by your marginal tax rate. A $50,000 exemption would mean that you could spend up to $50,000 a year without paying a penny in taxes.
But their government is pretty well established as not being particularly heedful of *spending* the tax income on social projects and such, so that gives them a bit of wider budgetary wiggle room for numbers discrepancies
and the gengars who are guiding me" -- W.S. Merwin
Isn't the situation currently uniform anyways? Aside from above the line deductions.
If you run a quick google search, you will find articles on the fact that very few of the "rich" actually pay taxes at the top marginal rate. Through the use of tax structuring, planning and industry specific deductions/credits, individuals and corporations with similiar incomes may pay very different amounts in taxes.
The exemption can be handled as a rebate check or by not requiring point of sale withholding (which means there is no wait). The difference between an income and consumption tax is really what happens above the exemption. Under a consumption tax, more will be saved, but when you buy things, you will just factor the tax into the cost (just like how sales taxes work now). If people choose to save all their money and never spend anything, national savings rates increase, which has a number of benefits for the economy. If people choose to spend (and most people will continue to buy things like cars, houses, clothing, meals out, etc) then the government will collect its taxes on that spending, including spending by companies (which will have more available capital to spend, since people will be investing more of their income in those companies).
On the question of the disabled, I guess the question is why wouldn't we tax them? If they have money in excess of the exemption and choose to spend it, I'm not sure that I understand how that is a problem. We tax people on disability income now (at least in certain circumstances), so it wouldn't really be different.
Oh no, currently I'm in total agreement with the above. I just was saying I think that's what it should be. Looking back at our economy in times of prosperity in general the USA seemed to work best when there was a high level of progressiveness in income tax and larger amounts of government spending on social programs. So it just at least to myself makes sense to try and understand why that seemed to work (Incomes prevented from stratifying too much and downwards redistribution to prevent social decay that occurs when you allow unlimited property and capital accumulation by individuals or business entities.)
Whether the world has "moved on to consumption taxes" are irrelevant. Are the consumption taxes actually doing good or are they not? Before you can even ask that question you need to have decided on what the purpose of taxation even is.
How will you know if your policy is succeeding or failing unless you have agreed on what success or failure even looks like? You can't do that without first forming consensus on a purpose of taxation and yes, you actually can have a productive discussion on the issue. It's just that you can't allow people to duck out by claiming they don't need to have a reason or explain their views and why they hold them. People are entitled to a subjective opinion but they aren't entitled to have it enshrined in law. But you can form a consensus by asking everyone what they want to get out of a given system and try and find the common ground in what everyone's after.
This works with people who are required to have a reason informed upon facts for their opinions. The reason consensus breaks down in politics usually is because congress is allowed to be stupid and unreasonable and as long as they parrot whatever sound bytes their voters happen to tangentially agree with (versus actually educating them and then getting their informed opinions) then they can argue dishonestly and talk past each other rather then actually pass meaningful legislation to help people's lives. When you educate people about things you'll find they can very quickly agree to things now that they know themselves what they want.
But why is the tax better? You can't even tell me why it's better for a reason other than (everyone else is doing it!) which is completely vapid. You raise revenue because as a government you need to do big things, the point of taxation shouldn't just be to raise revenue though. If you let yourself be that short-sighted then you'll end up with a Feudal tax structure, much like ours is slowly becoming. Where the lion's share of tax benefits all go to the people at the top in either individual or business capacity. You're not going to avoid that without first establishing a common purpose that you want to achieve with your tax policy.
Once you know what success or failure actually looks like in real terms, then that frees you to think very carefully about the most efficient and fair mechanics to implement that vision of success. Without that though, is it any wonder that we're floundering in failed policies politically? We're doing things in a lot of cases just because we want to, and then invent vapid reasons to justify to the public how something unhelpful is somehow helpful to them when all it does is entrench further the established system and lock power into respective place.
How do you prevent the former from resulting in a situation were I theoretically spen $0 and just make $5000 at the end of the year?
How do you track how much tax someone owes at the end of the year with the later method?
We use income tax in large part because there is a built in paper trail for how much income you have made in a year.
What you are describing actually is exactly how the current system works, except that corporations pay a different marginal tax rate, and non-profits are exempt from taxes. Partnerships (and LLCs that do not elect to be treated as corporations) are pass through entities, meaning that they pass all their profits and losses directly to the partners, who pay taxes at their individual tax rates. Corporations pay an extra level of tax, but also have the ability to hold money without the investors being taxed (i.e., to keep working capital). If we got rid of corporate taxation, then you would have to pay tax on the income of any company whose stock you owned, even though you would not get that income. I think the special treatment you are thinking of is just the "standard deductions and tax credits to encourage or discourage certain behaviors and businesses" you said are ok. And these deductions are things like the deduction for buying equipment and paying salary and benefits, which are of critical importantance to things like job creation.
All of these attacks on corporate personhood confuse me. Corporations exist for one simple reason: limited liability. If there was no such thing as limited liability, meaning that all investors in a company would be liable for the debts of that company, then noone would invest and the economy would grind to a halt.
The problem with your respectful disagreement is that it flies in the face of of the historic evidence. During the period of low income inequality in the 50's and 60's, the US had a strongly progressive income tax with high upper brackets. As the brackets were flattened, income inequality has increased.
Self reporting on sales taxes doesn't work. There's a reason states have been fighting with Amazon.
Because you can have limited liability without personhood. In fact, that's a goosey argument.
Yes, because it's a sales tax. It's like asking if the Pacific Ocean is wet.
That is incorrect. You can structure a sales tax so that the incidence is uniform or even progressive (such as luxury taxes). If you had a sales tax that only applied to luxury cars, clothing over $500 per item, and yachts, I don't think it would make sense to classify it as regressive.
Your second point is also wrong, i don't think there are any advanced economies who don't gain most of their revenue through progressive income taxes on companies and people. Sales taxes paid by the consumer are solidly in second place.
Income inequality has to be tackled by higher rates on the rich, nothing else can help.
Self reporting on sales taxes doesn't work the way that we currently enforce them. But, if for example we required you to provide a tax payer identification number along with all purchases, then withholding would occur at the point of sale. That said, the US tax system is the most successful self reporting system in the world, and the administrative cost associated with each dollar collected is amazingly low. But I'm not advocating a change to a consumption tax in this thread (to be honest, I'm not sure how I feel about one, even after years of having all of my tax policy professors from both political parties argue in favor of a consumption tax at NYU law).
Um, yes, it would still be regressive. It would only be regressive in the pool of impacted individuals, but it would still be regressive.
Usually tax simplification is about removing some/most/all (depending on who you talk to) of the hojillion deductions, exemptions, and credits (e.g. black liquor). And maybe taxing more types of income at similar rates (e.g. carried interest).