Treasury Secretary Steven Mnuchin listens at right as President Donald Trump speaks during a meeting on the Federal budget in the Roosevelt Room of the White House in Washington.
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Federal tax reform is a major topic in American politics today. From members of Congress to our next-door neighbor, everyone seems to have an opinion about the simplest way to tax ourselves.
Avoiding the word “fair” when discussing tax reform is important. It’s difficult to define because it’s so subjective. Achieving congressional agreement on tax reform is never easy, but imposing an additional “fairness” requirement makes it almost impossible.
Congress will have its hands full achieving “just” tax reform — giving equal treatment to taxpayers in similar circumstances.
Tax deductions and credits are a convenient starting point for discussing tax reform.
Many of these items were enacted either in response to perceived needs or because of intense lobbying efforts. Deductions and credits have been called “loopholes” and “social engineering.” Although enacted to encourage certain behaviors, the jury is still out on their overall effectiveness.
Individual itemized deductions include mortgage interest payments and charitable contributions, although most taxpayers take the standard deduction. Other deductions, such as moving expenses and interest on student loans, are generally available whether or not the individual itemizes. Tax complexity increases, in part, because each deduction is supported by a separate set of regulations, exceptions, and qualifications.
By eliminating individual deductions, taxable income increases. As it is broadened, tax rates can be lowered for all brackets, while still preserving our progressive tax system and revenue neutrality.
Contrary to popular belief, the number of tax brackets doesn’t add much complexity. The majority of individuals either use the IRS tax tables, where the tax is already computed, or employ software or a professional preparer.
Eliminating deductions also promotes transparency. If Congress desired to change taxes, it could merely adjust the tax rates, or enact a surcharge, as it did in 1968 and 1969. These changes are easy to identify and their impact calculated.
Tax credits reduce the tax itself for both individuals and businesses. For individuals, several different categories are available, including credits for residential energy and education. Business tax credits total at least 30 separate items, including biodiesel fuels and research and experimentation costs. Each credit has its own set of regulations and exceptions, which further increases tax complexity.
But, if eliminating deductions and credits to achieve simplification sounds appealing, remember the old proverb: Be careful what you ask for. Deductions and credits exist to reward certain types of behavior, such as charitable donations, buying a home rather than renting, or investing in research and development.
The larger question: Do we want government to encourage and subsidize certain types of activity, which almost always leads to more tax complexity? Or would we prefer to make these decisions independent of any tax ramifications?
The list of tax reform topics is long. Congress needs to examine such areas as defining a “profit motive,” the Alternative Minimum Tax, qualified dividends, tax rates for capital gains, and taxing profits earned abroad.
A tax system, like the government it funds, is a tool intended to promote the common good. However, all too often the tool becomes outdated, dull, warped, or even misused.
That’s why it’s important to periodically examine the tax code to ensure that it furthers the common good while still respecting the individual.
Unwinding a complicated tax code such as ours will be a long, slow process. Many economic sectors will be affected. Controversy is sure to arise and lobbying pressure will be intense. But the perception and reality of our nation as a place that rewards work and is attractive to both domestic and foreign business depends, in part, on the quality of our tax code.
We need to begin the journey sooner rather than later. This problem won’t solve itself.
Phil Schurrer, a retired CPA, is emeritus lecturer of accounting and taxation at Bowling Green State University.
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