Cut Taxes, But Simplify Them Too

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As Congress works out the details of the $1.35 trillion tax cut plan, acongressional committee has reminded us that we need more than this cut tofix the tax system. The non-partisan Joint Committee on Taxation recentlyreleased a 1,300-page study that proposes dozens of tax simplificationsteps. While a good starting point for needed reforms, the report underscores why Congress should move to scrap the current income tax and install a simpler system.

Consider the dimensions of the current federal tax mess, as documented bythe committee: The federal tax code contains 1.4 million words. By my estimate, the Bible contains just 0.8 million words.

The tax code itself is only part of the mess. The federal tax system wouldn’t work without more than 20,000 pages and 8 million words of regulations fromthe Treasury to explain how the tax laws passed by Congress are supposed tobe applied.

The IRS produces 649 separate tax forms and schedules with a combined lengthof more than 16,000 lines and publishes 340 other publications with morethan 13,000 pages. Federal tax rules are so confusing that taxpayers contact the IRS with questions about 117 million times each year. The Treasury’s Inspector General recently found that one third of taxpayer phone calls do not get through, and of those that do, the IRS gives incorrect answers 47 percent of the time.

While it is easy to blame the IRS, the real source of these problems is thecomplex tax laws passed by Congress. Congress imposes its largest tax on“income,” which is notoriously difficult to measure and getting moredifficult all the time. For example, U.S. corporations now have ownershipstakes in more than 20,000 foreign affiliates. The corporate income tax isunder strain to accurately calculate what portion of global net income toimpose U.S. tax on.

On an individual level, broadened ownership of financial securities issubjecting more Americans to the headaches of capital income taxation,particularly capital gains taxes. A tax system that instead had a domesticconsumption base would reduce these difficulties.

Congress is also to blame for mucking up the tax code with a proliferationof “phase-outs,” “ceilings” and other limitations on who gets to receivespecial tax breaks. There has been a parallel increase in the use of thetax code for “social engineering,” which is steering narrowly focused taxcredits and deductions to politically favored individuals and industries.Again, a flat-rate consumption-based tax would rid the tax code of most ofthese complex provisions.

The current tax code’s complexity imposes a steep cost. The Joint Committee’s report notes that tax complexity increases time and money costs to taxpayers, reduces taxpayer compliance, reduces perceptions of fairness and increases the costs of government administration. The total administration and taxpayer compliance costs of the income tax are about $150 billion per year or more, about $1,500 for every household in the country.

The Joint Committee proposes reforms that would begin to bring back somesanity to the tax system. One important proposal is repealing the alternative minimum tax (AMT) on individuals and businesses. The AMT is essentially a separate income tax system parallel to the regular income tax. Supporters promised it would bring greater fairness to the tax system. Instead, it has created a huge amount of extra paperwork, costs, and planning difficulties for families and businesses.

The Joint Committee also proposes ending most of the “phase-outs” under the individual income tax. These are provisions that deny those with middle and higher incomes tax benefits enjoyed by other taxpayers. Phase-outscomplicate tax calculations and increase marginal tax rates. The reportsuggests repealing phase-outs on itemized deductions, personal exemptions, the child credit, individual retirement accounts, and other provisions to simplify the income tax for about 30 million families.

Congress and the administration should receive a number of messages fromthis report. First, they should do no further harm with this year’s taxlegislation. Tax changes should be favored that increase economic growthand reduce complexity, such as income tax rate cuts and estate tax repeal.Second, after passage of this year’s main tax bill, a major effort needs tobe mounted to codify the Joint Committee’s proposals to simplify the current system.

With lower rates and a simplified system, it will be easier to movetoward replacing the income tax with a pro-growth consumption-based system.