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 the 73,000 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 that provide, for example, 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 17. But there’s also a separate “child and dependent care credit,” which defines a “child” as somebody under 13. 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 19 — unless the person is a full-time student, in which case a “child” is anybody under 24.
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.
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. I believe 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 a new tax code and what should not.
The way to bring about fundamental change in a dysfunctional tax code is to start over — to rewrite from scratch. For instance, 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 former Senator Bill Bradley drew: “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. The Treasury Department says every individual and corporate tax bill could be cut by 37 percent 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. 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 80 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 percent to 25 percent 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 21st century because of the looming problem of inequality. Since the end of the Great Recession of 2008–2009, 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 10 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.
Some American politicians 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 percent applies only to income above $418,400 — which is to say, less than 1 percent 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. 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 tax reform of 1986 — capital gains were taxed at 28 percent, 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 (VAT) has been the most successful taxation innovation of the past 60 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 U.S. 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 (FAT). 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.
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 email so you could check it for accuracy. Assuming the IRS gets the figures right — and audits show that it does 99.9 percent of the time — filing your taxes could be reduced to a single click. And April 15 would be just another sunny spring day.
Most importantly, 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 complicated tax-avoidance schemes could be turned instead to productive uses that enhance the nation’s wealth and well-being.
At The Washington Post, T.R. Reid covered Congress and four presidential campaigns. His bestselling books include The Healing of America and The United States of Europe.
This article is featured in the November/December 2017 issue of The Saturday Evening Post. Subscribe to the magazine for more art, inspiring stories, fiction, humor, and features from our archives.
From A Fine Mess: A Global Quest for a Simpler, Fairer, and More Effective Tax System by T.R. Reid, published by Penguin Press, an imprint of Penguin Publishing Group, a division of Penguin Random House LLC. Copyright © 2017 by T.R. Reid.