Forming a Policy for Tax Reform

Forming a Policy for Tax ReformForming a Policy for Tax Reform

Policy statements and bills for tax reform appear every year from every area of government, business, and tax practitioners about how to improve the tax system. Unfortunately, much of the toil in the area of tax reform results in little change because our federal and state tax systems suffer from unbelievable inertia and legislators do not feel an incentive to innovate or change the tax system. What follows is an introduction into the problem of the alternative minimum tax at present, and a discussion of the flat tax under some policy criteria.After some study of the alternative minimum tax, it seems hardly likely that Congress will repeal the AMT because it is a big source of revenue for the federal government and repeal would result in considerable shrinkage of the personal income tax revenues of the Treasury. Why then advocate repeal of the AMT? Though repeal is not necessarily practical from a revenue raising point of view, it does follow from the policy behind the original implementation of the AMT: To make sure that wealthy individuals and businesses with many deductions paid at least some federal income tax. The AMT was enacted in 1986, a time when only really wealthy individuals and businesses that paid few taxes were subject to it. Today, many people who reside in states with high income tax rates or have more than three exemptions with an income in the middle five figures are likely to be subject to the AMT. The latter, in and of itself brings to mind the old adage that the power to tax is the power to destroy. The alternative minimum tax system is broken and needs to be eliminated, or at least changed radically in order that the original intent of the tax retain any integrity.Implementation of the flat tax is another important issue, but it is one that captures the attention of Congress typically in election years when candidates are differentiated. The last proponent of the flat tax of any note was Steve Forbes, who advocated the idea of Alvin Rabushka of the Hoover Institution, that the flat tax would greatly simplify the system of tax collection, result in an economic gain by eliminating costs of present compliance, and result in a more equitable stratification of the tax burden in this country. I believe that Dr. Rabushkas and Mr. Forbes and Dick Armeys ideas are on the right track, but their concepts are not particularly popular because there would be no immediate fiscal benefit from passage of flat tax legislation. The flat tax would call for fiscal discipline, and that is also why many legislators do not agree with it.

This essay will attempt to give reasons why a flat tax should be legislated within a framework of principles like policy fairness, certainty of regulation, tax minimization, compliance simplicity, tax neutrality, economic constructiveness, awareness of tax regulations, incentives for compliance, and revenue policy.*

We have in the United States a tax system which is progressive. That is the income tax is based more upon wherewithal to pay rather than based upon ability to pay. In other words, the tax rates are structured so that the more economic benefit is created, the more it is taxed. This is clearly against the spirit of innovation, entrepreneurship and hard work upon which our free market system is based. Taxes assure our rights of private property, civil liberties, and social freedoms as the government protects all of these. Because there is a price for the continuity of these rights, one might have the idea that high taxes are necessary, especially for those individuals with more property. The fact is our present system of taxation is unfair to those individuals who make our economic fortunes rise (both individuals and businesses) as they pay most of the taxes. The flat tax is a good idea because it does not discourage the creation of economic benefit (either personal or corporate) and is based upon the taxpayers ability to pay. One also has to agree that under the flat tax substantially more tax will be paid by the wealthy, but not at a higher rate.Regulation of the administrative rules of taxation would also be simpler under the flat tax as we could do away with the endless documentation on the various rules and regulations. We would also not have to deal with the complicated tax treatment of many transactions and the debate about how much tax is due for these transactions. Compliance under the flat tax would substantially reduce the complications of the current system, and the certainty of how much tax is due for each individual or business would not be compromised as it is under current rules.The flat tax would also be more convenient for taxpayers. Currently, considerable time for each taxpayer is spent each year collecting, processing, and making decisions about what is to make up the return. The flat tax would eliminate the many hours individuals and businesses spend to plan for the filing of their returns, an activity that each year costs billions of dollars to the domestic economy. The flat tax would minimize the burden of the preparation of tax returns, the overall burden of enforcement of the tax laws, and the burdens and procedures of collection placed upon the Treasury. The flat tax would also be a minimum tax: Each taxpayer would pay the same rate; the wealthy would still pay more tax, and the less wealthy less tax. As a result of the flat tax, the size of government would be no more than its revenues would support this would benefit both government and its taxpayers, as a tentacled bureaucracy would be at least somewhat reduced in size, and taxpayers would be subject only to a fiscal burden that assured the continuity of the federal and state governments without special favors to districts or legislators.Tax neutrality means that an individual or business would not engage in a transaction solely to avoid taxes. The effect of a flat tax on tax neutrality means that there would be a bare minimum of transactions that would have a tax effect so as to influence a taxpayers behavior about tax avoidance. The flat tax would discourage tax avoidance and the games played when tax avoidance strategies are carried out.

The individuals and businesses in the United States are currently overburdened with taxes. The extra burden benefits no one within our shores, really, as it impedes economic progress and wealth creation. It also results in a general level of higher prices in this country which has an effect on international competitiveness. The tax system in the U.S., with the programs it supports, is not aligned, and may even be entirely at odds with the economic system aimed at economic growth and capital formation. We are now in an economic world of great scale and scope, product differentiation and imperfect competition and our tax system has been built against our society profiting from these newer beneficial economic developments.The flat tax would create an environment of compliance with tax rules to encourage the payment of taxes through the enactment of simple rules, a comparatively low income tax rate (perhaps 15% to 18%), and the tax system would become transparent to everyone who was required to make payments to the Treasury. With a flat tax, the tax system would no longer suffer from its syndrome of inertia, nor would we have bureaucrats in the Treasury promulgating the law as is the duty of Congress. The government would assess periodically how much tax revenue would be needed to fund its operation, and the flat tax would assure that the government could not obtain a windfall through the legislation of new tax bills. Under a flat tax the tax system would be more predictable, and the federal government would be required to balance its budget. Further, the tax system would not be subject to the will of some individuals to have it be an instrument of social policy. Taxpayers would no longer be jolted by the frequent changes in the tax law that cause confusion among taxpayers and further complicate compliance efforts. The tax authorities themselves would not be burdened with documenting the frequent changes or enforcing the increasingly complex code.Under a flat tax, income would be taxed only once, with perhaps some allowances for family expenses for individuals and operations expenses for businesses. The present distortions in the tax treatment of individual transactions would be eliminated. Tax practitioners and legislators, and even opponents of the flat tax agree that taxes must be lowered and the tax base broadened. The flat tax meets all the criteria for good policy outlined above, especially economic constructiveness, simplicity and policy fairness.

Thomas H. Spitters

May 2003

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By Thomas H. Spitters, CPA www.fed-tax.com

copyright Thomas H. Spitters, CPA 2003, all rights reserved5