Tax Simplification

A proposal for tax simplification, by Jon Hall*

It was once thought that only a handful of folks really understood the Theory of Relativity. No one, however, entirely understands the U.S. Tax Code; it is complexity run riot, complexity on wheels. Even IRS agents give conflicting answers to the same tax questions.

But before Congress junks the U.S. Tax Code and the IRS for some untested replacement like the FairTax, Congress should first try real reform: radical simplification of the Code. Congress made a stab at simplification back in 1986, but it didn't stick. Complexity soon crept back into the Code, and continues to do so.

There are two main reasons for the complexity of the Individual Income Tax (other than the corruption of Congress). The first concerns figuring your total income. (This we can accept.) The second concerns figuring your taxable income and applying your tax credits; i.e., reducing your tax liability, so you won't have to pay as much. This second reason is where simplification must be focused. But fear not, read on.

If ALL the complexities involved in reducing one's tax liability were stripped out of the Code, folks would be paying higher taxes, right? Therefore, simplification demands a tax rate cut, so folks won't get hosed. And if done correctly, a rate cut will make simplification revenue-neutral.

Here's the fair way to figure the new tax rates: For each income bracket, divide the sum of what everyone actually paid in income taxes by the sum of everyone's total income. (To put it another way: Divide each income bracket's aggregate income tax revenue by the bracket's aggregate total income.)

Example: For those whose taxable income is more than a $1 million, the current rate is 35%. But, if our formula above shows that that cohort, on average, pays 30% of their total income to the IRS as income taxes, then 30% would be their new rate. One could think of the new rate as being the old real rate.

With the new rates, some would be paying more, and some less, but the average tax load would be the same as with the old statutory rates. Is that revenue-neutral enough for you? It's even possible that if some of a bracket's taxpayers had been taking large enough reductions, the bracket's majority would pay less under the new rates. In any event, everyone in a bracket would be treated the same, paying at the same rate. Fair enough? Perhaps we should call this reform "The Multi-bracket Flat Tax".

Of course, this has been an over-simplification of simplification; simplification is actually a bit more complex than this. The remaining complexity involves the lower rungs of the income ladder, where reducing one's tax liability is much more critical. It is there that unintended consequences could be particularly hurtful. If there is anyplace where reductions must be retained, it is the lower income brackets.

So, simplification would start at the top, with the top bracket. Confining simplification to the top bracket will only capture about 1% of the taxpayers. Applying simplification to the lower brackets—the 99% of us—would be phased in only after we see how well it works at the top. Simplification in the lower brackets may not be as pure as at the top; these folks need their reductions in tax liability. Perhaps the purer simplification advocated above should only be applied to those with total incomes exceeding $250,000, which is still well under the top 5%.

For 2006, the top tax rate (35%) began with incomes over $336,550. This bracket—if that's what you want to call it—covers far and away the largest range of incomes of any of the brackets, as it has no upper limit. Those making tens of millions in income pay at the same rate as those at the bottom of the bracket. To apply our formula to the entire bracket could expose those at the bottom to a tax hike. Therefore, this huge bracket should be broken up into several brackets, perhaps 10 or more. And then we'd just plug our formula into each of these smaller new brackets to find their tax rates.

The IRS could insert simplification into Form 1040 with the addition of a single question. On Line 22, where you report your total income, add this test: If your total income is greater than $336,550, go to the chart on page such and such. The chart would line up your total income with your tax rate, you'd multiple your total income by that rate, and then you'd be directed to go to Line 57 and enter your tax there, bypassing 35 lines, as well as all the forms and publications associated with those 35 lines. Or, perhaps, the IRS could devise a new form for the rich, an alternate Form 1040EZ. In any event, if you're a high earner, just multiply your total income by your rate and be done with it.

Such tax simplification would simplify the lives of the well to do, enabling them to concentrate on the intrinsic worthiness of their investments and charities, not how they affect their tax situation. If some VIPs resent the loss of their pet write-offs, they should consider the resentment of the other taxpayers who've been making up for them. For whenever one taxpayer gets a tax break, the other taxpayers making up for that lost revenue become subsidizers of that tax break. And what's worse, the tax break may be for something the other taxpayers strongly disapprove of.

But simplification isn't just for the taxpayer; it's for the IRS, too. Simplification of the Individual Income Tax would free up manpower at the IRS. But it needn't cause a rise in unemployment amongst the ranks of CPAs. For instead of checking whether folks were entitled to their deductions, exemptions, write-offs, loopholes, credits, adjustments, and such, these fellows could be tasked with collecting the billions of dollars of income taxes that go unreported and uncollected. They'd be concentrating on Lines 7 through 21 of Form 1040. And they could also work on capturing the lost revenue from the underground economy, adding a little spice to the life of your average IRS auditor.

Of course, Congress will always be tempted to pack complexity back into the Code, granting favors, picking winners and losers, pitting taxpayer against taxpayer. However, Congressmen who want to reform the U.S. Tax Code need just one word—simplification.

*Jon Hall is a mainframe programmer/analyst from Kansas City. The views expressed are his own, and do not necessarily reflect those of the PPTO.

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Date last modified July 8, 2008