TAX REFORM: DOES IT EVER END?March 29, 2017 | Category: Corporate and Taxation
Copyright © 2017 Robert M. Kramer
The short answer is no. Although everyone agrees that reform is needed, the devil is in the details. Or in other words, whose ox is getting gored?
Economists have three criteria to evaluate tax policy: equity, efficiency and simplicity.
Equity pertains to the fairness of the tax law. There are two types of equity: horizontal and vertical. Horizontal equity concerns itself with whether two taxpayers with similar incomes pay similar taxes. Vertical equity looks at the
distribution of the tax burden among various income groups.
Efficiency pertains to how the tax law affects economic decision making. Does the tax law cause individuals to alter their economic decisions? For example, the mortgage interest deduction encourages taxpayers to purchase homes. Accelerated depreciation causes businesses to purchase equipment, etc. The U.S. tax system is highly inefficient in that there are built-in subsidies for everyone, it seems.
Simplicity is concerned with how much time and effort taxpayers and their advisers must spend keeping records, computing the tax, filing returns, etc. and with the government’s burden of administering and enforcing the tax law. The U.S. tax systems demands a tremendous amount of resources and thus is far from simple.
A Look at Recent Proposals
One proposal is focused on a broad-based tax system with lower rates, a larger standard deduction, and fewer itemized deductions. While this makes
the system simpler and more efficient, its effect on equity is questionable.
Another proposal does away with the income tax and substitutes a broad –based consumption tax; specifically, a national sales tax. The Fair Tax Act of 2017 imposes a 23 percent consumption tax on the total price including the tax (or approximately 18.8 percent tax on the selling price before the tax.) This supposedly is revenue neutral. Lower income individuals would receive a tax rebate to promote equity. This certainly would improve simplicity, but how it affects efficiency is open to debate. Taxpayers may just decide to consume less.
The Simplified, Manageable, and Responsible Tax Act, or the SMART Act, would tax all wages, pension distributions, unemployment compensation and Social Security contributions. The Act would exclude Social Security payments. Married couples would get a standard deduction of $28,960. An additional standard deduction of $6,240 per dependent is allowed. The tax rate is 17 percent for everyone. While the individual portion of the proposed law is simpler than our current system, it would create vertical equity issues.
Due to the broad base of income and low rate, it does well on efficiency.
Under this proposal, businesses would pay a 17 percent tax on the difference between (i) revenues less (ii) the sum of purchases from other firms, wage payments and pension contributions. Notice there is no deduction for the employer’s portion of Social Security taxes, other fringe benefits and state and local taxes. While simpler, it has horizontal equity issues as businesses in different endeavors may pay dissimilar taxes on similar incomes. Those businesses that are heavy on employees, such as CPA firms or medical offices, are at a disadvantage.
If it were up to me to come up with a better system, I would continue the i
ncome tax for higher earners, but at lower, progressive rates, and impose a consumption tax on everyone. For example, a 10-30 percent income tax for the top 25 percent of income earners, and an 8 percent consumption tax for everyone, including the top earners.
Around 86 percent of income taxes are paid by the top 25 percent of income earners. That being the case, it would be far simpler to exempt 75 percent of the population from this burden. Everyone would be subject to a consumption tax to make up the lost revenue. The hard part is to agree on exemptions. Should food be taxed? How about gourmet food? Should medical care be taxed? Whose ox is being gored?
I think you get the point.