Ah, the blithe joys of springtime in the United States of America: azaleas in bloom at the Masters, school trips to the state capital, big sales at the garden stores, baseball’s opening day, picnics in the park on bright, breezy April afternoons—and the ordeal of Form 1040, with instructions like this one from the Internal Revenue Service: “If you determined your tax in the earlier year by using the Schedule D Tax Worksheet, or the Qualified Dividends and Capital Gain Tax Worksheet, and you receive a refund in 2016 of a deduction claimed in that year, you will have to recompute your tax for the earlier year to determine if the recovery must be included in your income.”1
The U.S. tax code often seems to be at war with the taxpayers. The tax law has become so stuffed with obscure provisions that were important to some group or other at some point in time that the mess just becomes too difficult for anybody to understand or to manage. The resulting complexity—made worse by the so-called anti-complexity clause that Congress threw into the stew some years back—has reached absurd dimensions. When I asked the commissioner of the IRS whether anybody in his agency has read all seventy-three thousand pages of IRS regulations, he laughed at the very suggestion.
At the same time, the tax code often seems to be at war with itself. There are many provisions, for example, that provide benefits or preferences for families that have a child. The problem is that the different sections of the Internal Revenue Code can’t agree on what constitutes a “child” for tax purposes. There’s a “child credit” in the personal income tax that applies to any person under the age of seventeen. But there’s also a separate “child and dependent care credit,” which defines a “child” as somebody under thirteen. For families getting the earned income tax credit (that’s the reverse income tax that sends checks to taxpayers who have low-paying jobs), a “child” is any person under nineteen—unless the person is a full-time student, in which case a “child” is anybody under twenty-four. Every time Congress decides to give a tax break for having a child, it just picks some definition of “child” and stuffs that language into the tax code, regardless of how many other designations of “child” have been stuffed in the code somewhere else.
This has been going on since the birth of the federal income tax a century ago. And history has shown that every three decades or so the tax code becomes so huge and complicated and contradictory that the only way to fix it is to scrap the whole mess and start over. The thesis of this book is that, by looking at other industrialized democracies that have faced the same tax questions we’re dealing with, we can decide what should be in this new tax code and what should not. That’s why the U.S. Treasury secretary in 1984, Donald Regan, dispatched his policy experts to look at other systems and bring back the best ideas—a process that ended with the dramatic tax changes of 1986, widely recognized as the most sweeping, and most admired, reform in the history of the U.S. tax code.
Here at home, our political leaders talk about fixing the tax code all the time. But their proposals involve incremental change to the existing system, and incremental change, over the decades, is what got us into the fine mess we’re stuck with today. These approaches to tax reform, including the plans we heard during the 2016 presidential campaign, all suffer from the same problem: they’re too timid.
They all have a rearranging-the-deck-chairs quality at a time when the whole structure is sinking from its own weight. As we’ve seen in other countries, the way to bring about fundamental change in a dysfunctional tax code is to start over—to rewrite from scratch. In chapter 4 of this book, the New Zealand parliamentarian Maurice McTigue explained why his country was able to scrap a decrepit, inequitable, inefficient tax code and replace it with a system that has won plaudits from tax experts everywhere. “A key reason was that we did it big,” McTigue said. “They changed almost everything at once. And that’s an important lesson: if you’re going to do tax reform, you’d better make it a large reform. That way, for every change a taxpayer doesn’t like, there’s something else in the package that he wants.” It’s the same conclusion the former senator Bill Bradley drew from our country’s successful revamp of the Internal Revenue Code in 1986. “You can’t just tinker,” Bradley said then. “Facing a huge, almost incomprehensible system, you have to take it on. Your goal has to be to fix the whole damn thing.”
For the U.S. personal income tax, fixing the whole damn thing means that the whole boatload of exemptions, exclusions, and tax-free income clauses should be jettisoned. If the employer pays part of a worker’s health insurance premium, that’s a fine thing, but the payment should be taxable income to the worker. If a taxpayer decides to buy a $105,000 electric-powered sports car, that’s great, but we shouldn’t give her a $7,500 tax credit to honor this indulgence. This is the “broad base” element of BBLR—broad base, low rates—which is the essential formula for successful tax reform.
Would American taxpayers go along if Congress eliminated all their deductions and credits? That’s where the “low rate” side of the BBLR equation sinks in. To win support for eliminating the giveaways, Congress cuts everybody’s tax rates. As we saw in this book, the Treasury Department says every individual and corporate tax bill could be cut by 37% if all the exemptions and such in the tax code were eliminated. Beyond that, getting rid of all the exemptions and such would make filing taxes vastly easier. So the average American would get a much lower tax rate and wouldn’t have to pay H&R Block to fill out all the forms.
Moving to BBLR is an area where purity is essential; we need to get rid of all the “tax expenditures” in the code—not just some of them—no matter how widely used they are. Then the tax writers in Congress can say to any lobbyist pushing for a particular loophole, “We don’t do that anymore. If you want to keep that deduction, we’ll have to raise the rates for everybody.” To emphasize this point, we should eliminate the two most popular deductions in the personal income tax: (1) the deduction for mortgage interest, which reduces revenues some $100 billion each year and provides the most benefit to taxpayers who need it least, and (2) the deduction for contributions to charity, which costs the government $50 billion per year and is even less defensible. It gives the biggest breaks to the richest taxpayers and assumes, incorrectly, that Americans won’t give money to good causes unless they get a tax break for it.
The same principle—BBLR—must apply to a revamp of the corporate income tax. As we’ve seen in this book, this tax just doesn’t work. American corporations that abide by the law end up paying a higher rate of tax than their competitors in other rich countries. Eliminating the hundreds of special provisions in the corporate tax code that benefit particular industries—or, sometimes, single companies—would broaden the base. The Government Accountability Office reported that the lost revenue from the eighty biggest corporate tax preferences in 2011 was $181 billion. Eliminate those, and the United States could bring in more corporate tax revenue with significantly lower rates. If the tax rate were lower, corporations would not find it worthwhile to indulge in convoluted schemes of avoidance; it would be cheaper and simpler just to pay the tax than to pay PricewaterhouseCoopers for a plan to duck it. If the preferences were eliminated from the corporate income tax so the tax rate could be reduced from the current 35% to 25% or less, this tax would almost surely produce more revenue with much less economic disruption.
“Warren Buffett paid a lower tax rate than his secretary.” This bumper-sticker slogan (which Buffett has confirmed to be true) captures a major problem with the current U.S. tax code. The picture of a billionaire paying a lower rate of tax than a middle-class working family runs counter to basic notions of fairness. The system of progressive taxation, of asking the richest to chip in the most to the common treasury, is even more important in these first decades of the twenty-first century because of the looming problem of inequality—“the defining challenge of our time,” as Barack Obama put it. Since the end of the Great Recession of 2008–9, virtually all of the increase in wealth in the United States has accrued to the wealthy. The rich are getting richer, and most others are not. A family at the median income takes in little more income today than it did ten years ago. This is gnawing away at the general population’s sense of optimism. The traditionally American notion that tomorrow will be better, that our kids will be better off than we’ve been, has become something of a sardonic joke for a considerable segment of the population. Naturally, politicians of every stripe have figured this out. When political leaders—ranging from Elizabeth Warren and Bernie Sanders on the left to Donald Trump on the right—declare that the American economic system is rigged against the average worker, millions of average workers roar their agreement. A progressive tax code can be a crucial tool for fighting the national problem of inequality.
Some American politicians—including several Republican presidential candidates in 2016—have called for a flat-rate income tax, in which the billionaire and the guy who pumps gas into her limousine both pay income tax at the same rate. But the flat tax just doesn’t bring in enough money, and a flat rate of tax fuels greater inequality. It means big savings for the rich, and higher rates for average people to make up for the shortfall. So the U.S. income tax should continue to keep a progressive set of rates. Indeed, the experience of other countries would suggest that we should make the highest marginal tax rate kick in at a lower income level than it does now. Other rich nations apply the highest rate of tax to about half of all taxpayers; in the United States, the top rate of 39.6% applies only to income above $418,400—which is to say, less than 1% of tax returns.
A tax code designed to offset (somewhat) the overall inequality of wealth and income should not give special tax breaks to the wealthiest. The “carried interest” provision—the clause that lets Warren Buffett get away with a bargain-basement tax rate—is indefensible. That’s why no other country permits this loophole for financiers and why both Donald Trump and Hillary Clinton promised to end it. It would also make a lot of sense to tax income earned from financial transactions (capital gains, dividends, and so on) at the same rates as income from wages and salaries. When Ronald Reagan included that change in the famous tax reform of 1986—capital gains were taxed at 28%, the same tax burden as the highest marginal rate on earned income—it had almost no impact on stock markets; the argument that rich investors need a lower rate of tax to put their money into the markets has not been borne out in history. Finally, there’s the estate and gift tax—adroitly nicknamed the “death tax” by its opponents, although the burden of it actually falls on the living people lucky enough to receive a multimillion-dollar inheritance. This has been an important tool for making the richest Americans help pay for the things we choose to do collectively through government. It’s a tax that doesn’t penalize work; if you worked for the money you received, by definition you don’t owe any estate tax. The estate tax should be retained, and probably increased, as a further weapon against inequality.
Two other major innovations, the VAT and the FAT, would give the federal government even more room to reduce both personal and corporate income tax rates. The value-added tax has been the most successful taxation innovation of the past sixty years. It has been adopted in every major nation on earth and in most small nations as well. The absence of a VAT is the most glaring hole in America’s tax code; we should use the occasion of a top-to-bottom tax reform to implement this tax and use the money it raises to cut taxes on work and savings. Countries like Australia, Canada, and the U.K. can show us how to harmonize a national consumption tax with state and local sales taxes.
The United States should follow the lead of the European Union and many other countries by enacting one particular form of a consumption tax, the financial activities tax. As we saw in chapter 9, the tax rate for this kind of levy can be tiny—$1 on a million-dollar trade. Because of Wall Street’s current obsession with high-speed trading—buying securities, selling securities, swapping securities, all in a few millionths of a second—this tax can add up to significant revenue while adding an infinitesimal cost to each transaction.
Taking the BBLR approach as the guiding principle of tax reform will go far to simplify the tax laws. If the tax code treated all income as income, and got rid of all the loopholes, the whole process of paying tax would be vastly simpler. And tax rates could be drastically cut. In addition, getting rid of all those preferences for specific taxpayers would mean we could eliminate the alternative minimum tax, a much-despised provision that forces several million taxpayers each year (both individual and corporate) to complete their tax returns twice, using different rules and rates each time.
Beyond that, the Internal Revenue Service should take over most of the work it now sticks on the taxpayer. Because of the reporting requirements it imposes on employers, banks, investment managers, local governments, and the like, the IRS already knows virtually every number on almost every tax return. The service could fill out your tax return for you and send it to you by e-mail so you could check it for accuracy. Assuming the IRS gets the figures right—and audits show that it does, 99.9% of the time—filing your taxes could be reduced to a single click.
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IF WE HAD THE GOOD SENSE, and the political courage, to undertake this top-to-bottom housecleaning of our tax code, the benefits would extend far beyond relieving American families of the annual April ordeal surrounding Form 1040. A new tax system built along the lines of successful tax codes in other rich democracies could enhance every corner of the national economy. It would give people the freedom to make big choices—Should I take that job? Could we buy that house? Should we choose that school for the kids? Can I start that business I’ve been dreaming of? Where should we invest our money? How much should we contribute?—without worrying about the tax complications. It would enhance the global competitiveness of American corporations and allow them to keep their money at home, to be used for investment or higher wages or bigger dividends to investors. Both individuals and corporations could invest their money in plans and projects and funds based purely on business considerations, rather than studying obscure implications of the capital gains tax. Even with significantly lower rates, the IRS could bring in just as much or more revenue as the current system, producing billions of dollars for new government programs, deficit reduction, or both. A revamped code would mean a federal tax system that works against inequality in a land where everyone is created equal. The enormous sums that Americans hand over today to consulting firms and tax lawyers for the design of “convoluted and pernicious” tax-avoidance schemes could be turned instead to productive uses that enhance the nation’s wealth and well-being. The billions of dollars and billions of hours that ordinary taxpayers must spend today just to calculate their tax bill would be available for more enjoyable and beneficial family pursuits. And April 15 could be just another sunny spring day.
The task ahead of us, therefore, is clear: the United States needs a completely new Internal Revenue Code, built around the principles that have made the tax codes in other advanced nations fairer, simpler, and more efficient than the one we’re stuck with today. For tax codes, there comes a point where the sheer accumulation of complicated and contradictory stuff requires that the “whole damn thing” be replaced.
In the past, we’ve scrapped our tax code, and started over, every thirty-two years. The last time that happened was 1986, when Congress produced a much-praised act of tax reform. Which means the time has come again to scratch that thirty-two-year itch. To fix our costly, complex, inequitable monster of a tax system, the United States needs a new beginning: the Internal Revenue Code of 2018.