Tax Reform Part I: Suggestions for a New System

The most pervasive influence in the country today is not reality television or politics but taxes. They are everywhere- income taxes, gas taxes, taxes on alcohol and tobacco, property taxes, employment taxes, sales taxes and on and on.

 Everyone has an opinion on our great national system of funding, or partially funding these days, the government. Rates are too high, too low, it is too complicated, picks winners and losers, discourages saving and investment, it is fair or grossly unjust. Maybe all of these apply in some form of the other.

However, in spite of all the opinions and political rhetoric, taxes are actually a very complicated subject. Not just in deciding what is the best system but also to figure out the politics in reforming it, or dare say, installing a new system.

 Devising the “optimal” tax system is an inherently subjective process: It involves weighing often-conflicting economic and social goals. Economic incentives and growth must be considered against the need to raise revenue. The desire to keep rates low brushes against the historical precedent of progressivity. Of course, complexity, administrative burden and compliance are also important.

The purpose of this column and the next two to follow is to examine the basic sources of government taxes and to suggest possible changes. It is not easy to re-write the entire Tax Code in such a short space. It will be like a puzzle with a few pieces missing but hopefully will raise some issues to think about.

 There are several classical principals, which are usually applied to the design of a tax system. Suffice it to say, in my opinion; the system we now employ lost its direction some time ago. It is broken, not really functioning on all cylinders, is honeycombed with exceptions and nuances within nuisances and needs a drastic make over.

The most important function of a tax system is to raise revenue to pay for the legitimate and agreed upon expenditures of government.  The level of revenue and what government does with its money are intertwined with the tax system. For example, effective rates that are too high and take too much money from the “private sector” (which means most of us) will crush incentives; cause capital shortages and anemic growth. On the other hand, effective rates that are too low will starve a segment of the population depending on government for a helping hand, imperil national defense and distort capital markets due to government borrowing

 So here is my criterion for a good tax system.

 Equity and Fairness- This is the most controversial part of the current debate on taxes. What is fair? How much should a person pay? I contend there is a limit. At some point, it’s not fair or right for the government to increasing take what a person has earned. Ability to pay is an essential element but needs to be put in perspective. I also content each person needs to make a contribution. The system is not healthy if the goal of half of the people in the country is to receive money from the other half.

Certainty and Predictable- Taxes should be predictable. No more temporary this or that. No more expiring provisions for political or budget games. Investment, retirement and consumer buying decisions depend on the ability to plan. The number of expiring and temporary provisions currently in the law is shameful.

Simplicity and Minimize Administrative Burden- A good number of tax analysts contend the current system is burdensome and costly. Records to keep, filings, schedules, documentation, forms, lawyers, accountants are in many ways non-productive costs. In addition, the government should be able to collect without a costly massive bureaucracy and an aggressive tax police.

 Neutrality- A good tax system should be as neutral as possible. Favoring one type of investment or conduct over the other-no matter what is perceived by some as a worthwhile social goal-distorts the system, picks winners and losers and is inefficient in the allocation of resources. This is where all the preferences, exemptions, deductions, credits, exclusions and revenue type come into play.

 Economic growth and efficiency- The system should not create huge incentives to avoid paying taxes, such as excessive rates or burdensome compliance costs and should not skew or destroy incentives to work and invest.

The biggest hurdle to improving the tax system is the politicians. The reason the Tax Code is a mess and littered with a bunch of garbage and narrow provisions is no secret. A coveted seat on the House Ways and Means Committee or the Senate Finance Committee guarantees bunches of political contributions by Political Action Committees, well-heeled donors and lobbyists for big and small business. It is relentless. A lobbyist once followed me into a men’s room to grind me about some special provision. I am not saying the Members are corrupt but the system is overly influenced.

There are those that advocate a scuttling of the current system in favor of a consumption tax, value added tax, flat tax, or national sales tax or whatever creature that can be invented. Not going to happen. The entrenched interests will not allow it and the political will and public understanding for a huge change does not exist. Therefore, we are stuck improving what we have. The Federal income tax has been around since 1913 and has for the most part served the country well. However, it can and should be better.

 Jack. O. Nutter is a partner in the Washington DC firm of Nutter & Harris. Mr. Nutter is former tax counsel to the U.S. Senate Finance Committee. His further comments on tax, economic and political issues can be found at jacknutter.com and by e-mail at jack.o.nutter@gmail.com

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