President Obama delivers a State of the Union address today. He will probably mention the current inequity of tax rates among the wealthy and the not-so-wealthy. Changing that is a good thing. If he calls for tax reform, I think that is a mistake. This is a huge topic which I am going to simplify (in hope that it will be read), falling into the same error as those (smart people) who call for a less complex code.
The U.S. Income Tax Code is complex for two reasons:
1. Income is complex. Accounting translates human activity into numbers. It is practically miraculous in how well it works, indeed, that it works at all, but is understandably complex. It is not perfect as seen by the credit default swaps debacle or its difficulty to detect pyramid schemes, but generally it works. You could make income tax as simple as possible by saying that it is just a percentage of income, but you still have all the complexity of dealing with income.
2. The tax code is a low-overhead method for the federal government to encourage certain behavior. From drilling oil wells, to lowering rents, to encouraging education, the tax code does not require expensive, inefficient government agencies and services. It just offers tax benefits and presto!, people respond. (I was going to give an example with depreciation of apartment buildings, but I will save any further explanation to the comments if readers are interested.)
Throughout history, every change of income tax law has been called 'Tax Reform', and every change of income tax law has made it more complex—by spawning behavior which was unforeseen by the writers of the legislation. Loopholes had to be filled, exceptions had to be made. Another problem with 'Tax Reform' has always been special interest groups, which are not seen as beneficial behavior for the nation, but need to be satisfied in order to get the legislation passed.
As contradictory as it sounds, perhaps the best reform is to keep the code as it is. This allows taxpayers to get familiar with the law. Change is often upsetting, and this is true in tax law. However, I also understand that society changes, different behavior is wanted, and perceived inequities need to be corrected. There are times when small changes in the law are an advantage to society.
And I'm not even going to address those 'reformers' who think that reading a chart with different tax rates on it is complex. That's like saying a book is too complex because its too difficult to turn to page 53. Anyone who can't find or calculate their tax rate must be either a criminal or a child laborer.
It's not necessarily bad to tweak the tax code, but people who advocate 'Income Tax Reform' really need to know what they are proposing. Plus, the U.S. Income Tax Code is actually very simple—just file a 1040EZ.
2 comments:
Great blog. We've spoken about this before. The idea that what makes the tax code so darn complex is the graduated tax rates is nothing short of laughable.
Of course, deductions do make the tax code more complicated and have nothing to do with raising revenue. But, its more likely that we will unilaterally disarm than it is that we will ever do much more than tinker with the big deductions. Getting rid of the mortgage deduction alone would send the housing industry into such a tailspin that people will yearn for the days of the sub-prime mortgage crisis.
I have a lot lot of respect for Andrew Sullivan, but he missed the boat on this one.
Thankfully, Obama's address did not call for "Tax Reform", but there were many Tax Code invocations. Particularly disturbing to me was his many requests for U.S. manufacturing tax breaks
Again, this is complicated and I don't pretend to know all the issues, but many economists would say that it is generally more efficient to place your resources in what you do well, rather than artificially support industries that others can do better. It also doesn't help start-up manufacturing, since they lose money their first few years.
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