Real tax reform

It requires real sacrifice.


If there were ever a time for Congress to undertake comprehensive tax reform, it is around the April 15 income-tax filing deadline (April 18 this year, because the 15th falls on Saturday). That’s when Americans, pulling their hair out over the demands of filing even a simple return, would gladly sign on to tax reform of any kind.

Individuals and businesses in the U.S. spend a combined 6 billion hours a year — that’s billion with a “b” — complying with the tax code’s filing requirements, according to Nina E. Olson, the Internal Revenue Service’s taxpayer advocate. (Yes, you have an advocate at the IRS, but you probably want to wait until after tax time before telephoning her.) And that’s before any IRS audits or follow-up notices requiring a response.

Because time is money, those 6 billion hours devoted to tax avoidance, compliance, and preparation equate to an economic loss of $234 billion, according to the National Taxpayers Union. Just think how much better off we would be devoting that time and money toward productive activities.

With President Donald Trump and Congress striking out in their attempt to repeal and replace Obamacare, tax reform is the next item on the agenda. Corporate tax reform is the easy one. Reducing the U.S.’ 35 percent statutory corporate tax rate, the highest among developed nations, would remove the financial incentive for U.S. companies to relocate overseas. All things being equal, businesses would opt to remain, invest, and create jobs in the U.S. A lower tax rate would level the global playing field, making U.S. companies more competitive.

Corporate taxes make up only a tiny portion (11 percent) of total federal revenue. Individual income and payroll tax payments combined are the major revenue source for the federal government. That’s where tax reform becomes tricky.

The reason has little to do with the partisanship in Washington; with philosophical differences over who should pay how much in taxes on what type of income; or even with the pros and cons of implementing a border-adjustment tax, which would tax imports and exempt the income derived from exports. The real impediment to tax reform is the special interests that represent every kind of favored tax treatment.

Take the mortgage interest deduction, for example. The federal government decided a long time ago that home ownership was a desirable goal. And what better way to induce the public to buy a home than to lower the cost? Homeowners get to deduct the interest they pay on their mortgage.

Then there’s tax-deferred saving for retirement. Because saving for the future is another “good” behavior, the government allows us to contribute pretax dollars every year to our 401(k) or IRA accounts.

If you are lucky enough to have employer-sponsored health care, you don’t have to pay taxes on the benefits you receive, unlike wage and salary income, which is taxed. Plus your employer gets to deduct his health-care expenses.

Add up all the deductions, exemptions, and loopholes, and the total cost of these so-called “tax expenditures” is an estimated $1.6 trillion, according to Congress’ Joint Committee on Taxation. The reason they are called tax expenditures is because these carve-outs function like government programs. But unlike discretionary spending on education, housing, and defense, for example, which are subject to annual appropriations by Congress, tax expenditures get no such review or approval. In fact, the mere mention of possibly eliminating some cherished loophole is greeted with an outpouring of lobbyists on Capitol Hill.

Just think about this: Congress spends more money through the tax code than it spends through appropriations. (Congressional appropriations for fiscal 2017 will amount to $1.15 trillion to $1.18 trillion, depending on the budget Trump submits.)

What’s more, bestowing tax advantages comes with a cost. Tax expenditures promote what economists call an inefficient allocation of resources. The money used to buy a home might have been put to better, more efficient use, investing in one’s business, for example. Instead, the preferential tax treatment distorts decision-making.

The only avenue for meaningful tax reform that does not increase the deficit is through the elimination of tax expenditures. Perhaps now you can understand why the last major tax overhaul was in 1986. No one wants to give up his or her tax breaks, most of which benefit individuals, not corporations. And each and every loophole has a well-funded constituency behind it.

When you grab a beer with friends this weekend, many of whom will have just emerged from the annual tax-preparation ordeal, ask them what they think about tax reform: about a simpler, flatter tax code that would free them from hours of paperwork; about lower tax rates; about faster economic growth with better job prospects.

What’s not to like?

Now explain to them the sacrifices it entails. See you next year on April 15.