Wednesday, September 17, 2008

Why Our @*$! Tax Code Is So Confusing

Bill Bischoll, a CPA, writes an article encouraging policymakers to simply the tax code and to stop using it to micromanage society.

THE RECENT CONVENTIONS included plenty of rhetoric about taxes. But the politicians in both parties missed the boat. Whether you think we need tax cuts or tax hikes, what we need even more is tax simplicity.

Our tax system is falling apart because it's become way too complicated. Tax breaks are not as helpful as advertised because many taxpayers can't figure out how to use them. Tax increases don't raise the expected revenue because many taxpayers are unwilling to spend extra time and money to comply only to get a bigger tax bill for their trouble.

If you doubt that tax complexity is a huge problem, consider the fact that my personal copy of the Internal Revenue Code takes up over 8,500 pages of very fine print. Then there are many thousands of pages of regulations and other guidance put out by the IRS in efforts to explain how the tax law provisions are supposed to work. Then there are many more thousands of pages of court decisions dealing with unresolved disputes about how they are supposed to work. I can't keep up with all this stuff, even though it's my profession. The average individual or small-business owner has no hope.

And it's getting worse — fast! Just in the last nine months, Congress passed six significant new tax laws. Every one of them added more complexity, and there will be more new laws before year-end. This is change we can be disgusted with.

When guys like me who make a living from dealing with tax complications start ranting about too much complexity, it's time for you ordinary citizens out there to demand an end to the nonsense. Here's what you should be howling about to your Congresspersons:

Be Honest About Tax Rates
Much of our tax system's complexity is caused by stealthy provisions intended to penalize certain categories of taxpayers without explicitly raising anybody's tax rates. That way the politicians can advertise low rates for all while keeping their hands in your pocket. For example:

The dreaded alternative minimum tax, which hits many middle-income folks by disallowing deductions for dependents and state and local income and property taxes.

Tricky rules that can cause you to pay federal income tax on up to 85% of your Social Security benefits — even though you already paid income tax on Social Security taxes when they were taken out of your salary or self-employment earnings.

Phase-out rules that reduce or eliminate the chance for middle-income folks to claim the child tax credit and education tax credits.

I could go on and on, but you get the idea. It's time to tell the politicians to be straight with you by raising or lowering your taxes with easy-to-understand rate changes. The current practice of granting well-advertised tax goodies and then sneakily taking them away from less-favored folks has got to stop.

Stop Trying to Micromanage the Economy With Tax Policy
In general, lower taxes tend to encourage legitimate economic activity, and higher taxes tend to do the opposite. But the politicians want to micromanage.

For example, after the devastating Gulf Coast hurricanes in 2005, Congress enacted a bunch of exceedingly complicated special tax breaks intended to help individuals and businesses rebuild. This was on top of many billions worth of direct relief from the Feds and many billions more from charitable donations. In my opinion, the tax breaks were unnecessary overkill, but they sure added lots more complexity. The beleaguered IRS is still trying to catch up on issuing guidance about how all the special breaks are supposed to work.

Another example is the absurd new tax credit of up to $7,500 for eligible home buyers. (For details, click here.) The credit is phased out at relatively low income levels, and it has to be paid back to the government over 15 years. After all the billions and billions the Feds will have to spend to bail out mortgage lenders and Freddie Mac (FRE: 0.39, -0.07, -15.21%) and Fannie Mae (FNM: 0.61, -0.13, -17.56%), this goofy credit is an insult to our intelligence. It's not going to make the housing market recover any faster, but it sure makes the Internal Revenue Code more complicated while adding billions to the deficit. Great idea!

Lower the Tax Rate on Big Companies and Eliminate Corporate Welfare
Large U.S. corporations face a 35% federal income tax rate on their domestic profits. This is one of the highest rates in the industrialized world. As a result, big companies pay untold amounts to lobby Congress for unadvertised tax breaks (better known as corporate welfare) and to devise tax-avoidance strategies (some legit and some not). The high U.S. tax rate also encourages companies to move operations overseas and keep the resulting profits over there. Why? Because they generally don't have to pay U.S. taxes on offshore profits until they bring them home. So they don't.

As a result, the amount of federal income taxes that big corporations actually pay is laughably low. Although I can't prove it, I'm sure that a major reduction in the corporate tax rate combined with an end to corporate welfare would be great for our economy. Plus we could cut a few hundred pages out of the Internal Revenue Code as a bonus. This isn't micromanagement. This is a big idea.

Put "Fairness" in the Proper Perspective
A few years ago, the politicians became aware that lots of grandparents and aunts and uncles are raising children of their relatives. In the name of "fairness" Congress changed the rules to allow these nice grandparents and aunts and uncles to claim tax breaks, like dependency exemption deductions and child tax credits, for the kids they are selflessly supporting. The unfortunate result was rules that are so hideously complicated that I can barely understand them. Ordinary taxpayers have not a prayer. So now you have many cases where divorced moms and dads, along with grandparents and aunts and uncles, are all claiming the same tax breaks for the same kids. This is against the law, but it's up to the beleaguered IRS to issue audit notices and try to sort out the mess.

I can cite other examples of attempts to inject "fairness" into the tax law. Such attempts often result in rules that are too complicated to be effective — which isn't fair to anybody.

The Last Word
The purpose of our federal tax system should be to raise revenue in a reasonably predictable, efficient, and fair manner. The current system doesn't do any of these things — mainly because it's too complicated to work right. The problem has reached scary proportions, but don't blame the IRS. It's the politicians' fault. Now is a great time to tell them you want a simpler tax system if they want to keep their jobs.

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