Congressional Tax Reform: Forced to act?

This is the first of three articles on how to revamp the tax code. 

 

Congress has been debating reforming the tax system for some period of time. Now with the so-called “tax cliff” of massive tax increases beginning next year, the debate is reaching an important stage. Since the inception of the Obama Administration, liberals have been clamoring for a system that significantly increases the tax burden on higher income taxpayers (in spite of approving a 2 year extension of the 2001 and 2003 tax reductions in 2010) Conservatives have embedded themselves in a “no new taxes” mantra and a preservation to the aforementioned reductions)  

The time has come, gone and come again out of necessity for major decisions to be made. There is an opportunity to fix a system that is broken. However, it must be done in a way that will help the economy and fulfill the purpose of a tax system in the first place.

Taxes are the most pervasive influence in the country’s economy. 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.

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 to fund legitimate roles of the government. Of course, complexity, administrative burden and compliance are also important.

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.

 A few concepts  to consider: 

Equity and Fairness- This is the most controversial part of the current debate on taxes. What is fair? How much should a person pay? There needs to be a limit. At some point, it’s not fair or right for the government to increasing take and take and take. Ability to pay is an essential element but needs to be put in perspective. Also I contend each person who works needs to make a contribution. The system, indeed the body politic, 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 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- The current system is burdensome and costly. Records to keep, filings, schedules, documentation, forms, lawyers, and accountants are non-productive costs. The government should also 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 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 Tax Code is a mess and littered with a bunch of garbage and narrow provisions. It is a product of an entrenched political system but the Federal income tax has been around since 1913 and has for the most part served the country well. The revision of the law that will inevitably come will be forced by current day politics and shaped by the spending and taxing decisions of the past 10 years. It is all coming due.

The results of tax reform are not certain. They will depend on the divided political forces agreeing on an overarching system structure, compromising on some details and accepting others. Congressional leaders are not there yet but it is inevitable.