Fixing the American Tax System
Every tax season, I create a post exploring many different aspects of our system of taxation. It’s never a rant or a diatribe. It’s a discussion of the problems facing taxpayers and solutions that may help to fix the system. After all, nobody wants to hear about tax problems as the filing date approaches.
Simplifying the Tax Laws
There are very few things in life as inequitable, burdensome, complex and convoluted as the tax code. The government has been talking for decades about simplifying the tax laws. But, nothing ever seems to change.
There are 71,684 pages of regulations in the 2010 IRS tax code. This grows more unwieldy every year as new regulations are piled on and few are ever scrapped. This affects small businesses disproportionately, because they don’t have the accounting resources to comply with many of the laws. Often, companies must keep two separate sets of books, one for taxes and the other for profit and loss.
The tax code needs to be scrapped and replaced. Most of the 71K pages of code apply to a small minority of businesses and individuals. Hidden in all of those regulations are the special credits and loopholes companies have lobbied for. So, there will be intense pressure from special interest groups to preserve their tax perks. Politicians will never eliminate tax breaks for the companies who finance their campaigns. Nothing will change with taxes, until the tax system is changed.
Solutions:
- Sunset the existing tax code and replace it with a simple framework
- Prohibit modifications to the tax framework from any new legislation
- Force any changes to the new tax framework to be voted on separately
Make Everyone Pay their Share
There was a lot of buzz last month when the New York Times reported General Electric (GE) paid no corporate income tax last year, despite reporting $5.1 billion in U.S. profits and 14.2 billion in profits worldwide. Yet, the average American worker paid more for taxes than for food, clothing and housing combined. This has to stop. How can we ask the American working class to carry the tax burden avoided by multi-billion dollar corporations?
The U.S. has some of the highest corporate income tax rates in the world, but they are almost irrelevant. The effective tax rate (the amount corporations actually pay) has dropped dramatically in the past decade. There are so many credits and deductions, most corporations have no tax liability. Some tax credits are so specialized they are only available to a few companies.
Solutions:
- Minimum Tax Rate for all Corporations, Foreign and Domestic
- Tax penalties for multinationals using illegal transfer pricing
Replace the IRS with a New Agency
The IRS has consistently proven itself to be an unresponsive and inefficient collection agency. Some agents have abused their authority to the point of terrorizing widows and grandmothers. For years, it was nearly impossible to even reach someone in the agency by phone. And, responses via mail didn’t fare much better. The IRS taxpayer help line is notorious for giving out the wrong information and they still don’t have an interactive website for filing tax returns online.
To give the IRS some credit, they have a very complex and difficult job. It’s a massive undertaking and it’s critical to the operation of our government. But, a series of high-profile gaffs have cost the agency some credibility. There was a multi-billion dollar computer system upgrade that was aborted and a series of related glitches and security breaches. This year, there seems to be a glitch that sent thousands of refunds to the wrong bank accounts. Nobody is perfect. But, the IRS is an obvious relic.
If the tax laws were overhauled, it would make a lot of sense to start fresh with a new collection agency. There would be little need for the ancient proprietary mainframes, massive secure buildings and armies of agents and auditors. The new agency could be structured in a way that would encourage self-service and accurate filing by taxpayers, while discouraging brow-beating and bean counting by the government.
Solutions:
- Sunset funding for the IRS and create a new tax collection agency
- Eliminate the taxpayer is guilty until proven innocent mentality
- Modernize all aspects of the new agency for interactive service.
The Bottom Line
The bottom line is that a fair amount of taxes are necessary and proper. But, the unfair ways in which taxes are calculated and collected benefits wealthy special interests at the expense of the working class.
“The nation should have a tax system that looks like someone designed it on purpose.”
William Simon – Former Secretary of the Treasury
Recommended Reading
Investor Junkie – All About Taxes
Lazy Man and Money – Most Common Tax Filing Mistakes
Don’t Quit your Day Job – Tax the rich, Feed the Poor … Til’ there are No Rich No More
This post was featured on the Carnival of Personal Finance over at Financially Digital. This is the Greatest Carnival on the Net. Check it out.
Hi Bret, I agree with simplifying the tax code. It’s totally ridiculous and the IRS can’t agree on what the law is. I had a subscriber move back to Canada and every different IRS agent had a different opinion on what to do about his 401k.
Unfortunately, I think it’s going to be hard to change as so many are invested in it continuing this way. The IRS doesn’t want to disappear, neither does Intuit (Turbo Tax), H&R Block, or any other group that profits from the tax code being horribly difficult.
I’m sure you can imagine how I feel about profitable businesses like GE paying nothing in taxes while outsourcing jobs.
It’s definitely a huge mess and there are a lot of powerful entities invested in the status quo. But, it’s also reaching the point of absurdity and people may start to demand changes.
Fixing the tax code is probably the only issue liberals and the TEA Party could agree on. As for how to fix it, I don’t think they would like each other’s approach.
Hi Bret,
That whole tax thing is so true. The rich people are going to say that the poor don’t pay enough. The poor say that the rich don’t pay enough. There’s not much we can do about that.
But one thing we can do is make the whole thing simple and efficient. Most people will still claim it isn’t “fair” (whatever that means), but at least it won’t be wasteful. Throwing away billions of dollars on tax preparation, tax fraud, IRS agents and political bickering is stupid.
Maybe now that people are waking up to the fact that the government is broke they can get rid of all the parts that are useless. Like the tax code.
George
George,
It’s my opinion neither the corporations nor the lower middle class are paying their fair share. I deleted a paragraph talking about how 45% of households won’t pay any federal income tax this year. I figured somebody would take it the wrong way and accuse me of being a hater. But, we need 75-80% of households paying taxes, not 55%. And, we certainly can’t afford to give refunds to those who didn’t pay any tax in the first place.
If it wasn’t for all of the new tax credits, only 27% of households wouldn’t pay. That seems like a fairer percentage to me. If someone is unemployed or below the poverty line, they shouldn’t have to pay income tax. Everyone else should have to pay something, even if it’s only a couple hundred bucks.
Like I said in last year’s tax post:
“We have to get rid of the free lunch mentality, before we all go hungry.”
I sense there are going to be some big changes in the near future. Everyone seems to want change, but no one wants to pay for it. The entitlement mentality is bankrupting our country. So is the too big to pay mentality.
Bret
It’s ridiculously convoluted in many ways, I think a lot of people would agree with that. Of course, the current tax code has spawned a whole industry of people who make their living on this either as employee or proprietor (CPA firm partner, etc). Plus there are enough people who can pay the best to find loopholes for themselves.
I’m not expecting thigs to change and become simpler, quite frankly. But simplification would be nice for most of us.
“I’m not expecting thigs to change and become simpler, quite frankly.”
I think they just might. Let’s face it, there is a huge revenue shortfall and it’s going to be nearly impossible to raise taxes in this recession.
So, what makes the most sense? Taking away all of these credits and deductions, so the people who aren’t paying taxes will have to start. And, the people who are already paying won’t get an increase. That seems like the fairest solution to me.