What tax reform should look like
Now that the Republicans have been unable to accomplish anything with health care, they are moving on to tax reform.
Let us hope that they do not rush to obtain a quick legislative victory for the current administration with token, flawed and incomplete tax reform, much as the push for an early victory for President Obama resulted in the flaws and faults in Obamacare.
The creation and passage of the Tax Reform Act of 1986 was not a quick and easy process, and required strong leadership from a more polished, popular and experienced president, and much more bi-partisan support and cooperation than appears to be possible today.
That said, let me identify the principles I believe are required for true, substantive tax reform.
I have been preparing Form 1040s for individuals in all walks of life since February of 1972. I know full well that the U.S. Tax Code has grown into a complicated and convoluted “mucking fess.” The major reason for tax return errors, by both paid tax preparers and taxpayers who “self-prepare,” is the excessive complexity of the Tax Code.
I strongly believe:
1. The current U.S. Tax Code should be totally rewritten.
2. The one and only purpose of the Tax Code is to raise the money necessary to fund the government.
The new Tax Code must:
1. Be simple – easy for everyone to understand. Simplicity for simplicity’s sake.
2. Be fair and equitable - treat all taxpayers equally.
3. Be consistent – treat specific conditions, situations, and activities, and maintain specific definitions and descriptions, the same in all instances.
4. Encourage savings, investment and growth.
5. Index for inflation all allowable deductions and credits.
The new Tax Code must not:
1. Be used for social engineering, to redistribute income or wealth, or to deliver social welfare and other government benefits. This erroneous practice by Congress of using the Tax Code to deliver government benefits is the cause of much of the complication in the code and a large percentage of tax fraud, and is ineffective and improper economic and budgeting policy.
2. Encourage or discourage certain economic decisions (other than savings, investment, and growth), or provide exclusive benefits for specific industries, business activities, or classes of taxpayers.
3. Contain any refundable credits, or any phase-outs, exclusions or adjustments based on adjusted gross income or modified adjusted gross income.
4. Contain any “alternative” tax calculation systems (such as the current “Alternative Minimum Tax”).
5. Contain any temporary deductions, credits, benefits, or provisions.
The Tax Foundation, a nonpartisan educational organization, has identified six components of a sound tax policy, which I support:
1. Simplicity. Administrative costs are a loss to society, and complicated taxation undermines voluntary compliance by creating incentives to shelter and disguise income.
2. Transparency. Tax legislation should be based on sound legislative procedures and careful analysis. A good tax system requires that taxpayers be informed and understand how tax assessment, collection, and compliance works. There should be open hearings, and revenue estimates should be fully explained and replicable.
3. Neutrality. Taxes should not encourage or discourage certain economic decisions. The purpose of taxes is to raise needed revenue, not to favor or punish specific industries, activities, and products.
4. Stability. When tax laws are in constant flux, long-range financial planning is difficult. Lawmakers should avoid enacting temporary tax laws, including tax holidays and amnesties.
5. No retroactivity. As a corollary to the principle of stability, taxpayers should be able to rely with confidence on the law as it exists when contracts are signed and transactions are completed.
6. Broad bases and low rates. As a corollary to the principle of neutrality, lawmakers should avoid enacting targeted deductions, credits, and exclusions. If tax preferences are kept to a minimum, substantial revenue can be raised with low tax rates. Broad-based taxes also produce relatively stable tax revenues from year to year.
Put simply, good tax policy promotes economic growth by focusing on raising revenue in the least distortive manner possible.
PROTECTING THE STEP-UP IN BASIS
While I certainly support putting an end to the AMT, as indicated above, I am very concerned about ending the federal estate tax.
As we know, under current tax law when a person passes away, their beneficiaries get a step-up in basis on most inherited assets. This happens because of the existence of the estate tax, which values all assets at market value on date of death, or six months after the date of death. Eliminating the estate tax could also mean eliminating the step-up in basis.
Doing away with the step-up in basis would be disastrous – especially, I will selfishly admit, for tax preparers. Most taxpayers have no clue what they paid for investments they themselves purchased in the past. It would be almost impossible to properly determine the cost basis of an investment their grandparents purchased decades before they were born!
Repealing the estate tax would only benefit the wealthy. But repealing the step-up in basis would truly hurt many lower, middle, and upper-middle class taxpayers.
NOT A MATTER OF SELF-INTEREST
You may wonder, “Why is a tax professional is calling for a simpler tax system? Does not each new tax law, and each complexity added to the code, put money in our pockets? Is not a more confusing Tax Code better for business?”
A much simpler tax system would not hurt our, certainly my, business. I sincerely believe that if I did nothing but 1040As all day during the tax season I would make more money, experience less “agita,” and substantially reduce the number of extensions needed.
Most clients, certainly mine, would not decide to do their own returns if the tax system was simplified; they would continue to come to us. Most taxpayers who use a tax professional simply don’t want to be bothered with the task of preparing their tax return, and want to make sure they do not miss anything. And even with a more simplified tax system, there would still be a need to complete Schedules C, D, E, F, SE and related forms.
The only potential downside for the industry is with a simpler tax system more taxpayers would turn to tax preparation software, using a box instead of paid tax professional to prepare their returns.
A simpler Tax Code would most certainly reduce post-season IRS correspondence, issues and audits, and the accompanying stress.
Sadly, while I have identified above what I think true, substantive tax reform should be, I do not think this is what the final legislative package will actually look like.
But I can dream, can’t I?