It's that time again - more political babble about deficits, taxes, and tax reform. How do we reduce income tax rates while still bringing in the revenue with which to run the government and pay the bills? "Simple," say the Cassandras. "Reform the tax code, simplify it and close the loopholes."
We all complain about the complexity of the tax code. But let's face it - some of it is essential - business expenses, for example. Whether for large corporations, partnerships, limited liability corporations, or "mom and pop" operations, there must be guidelines and rules for determining legitimate expenses. Durable assets must be expensed over time. We can quibble about the rate and matters such as accelerated depreciation. But economically rational rules and sound accounting practice necessarily complicate tax codes to some extent.
There is the more controversial matter of credits and deductions in the tax code. This brings us to the philosophical issue of whether taxes should have the sole purpose of raising revenue or should intentionally be used also to influence behavior. For example, higher taxes on cigarettes raise revenue but also discourage smoking.
Deductions that reduce taxable income, and credits that directly reduce taxes owed, influence behavior. For example, the deduction for mortgage interest encourages home ownership, a generally accepted social goal. Tax credits for purchase of energy-efficient equipment are designed to save energy, another generally accepted social goal.
Here is where the illusions of tax reform come in. Politicians across the political spectrum take as given that it would be a good thing to reduce rates for federal income taxes across the board. After all, everyone would like a reduced tax bill, especially if there were no reductions in government services on which, admit it or not, we all depend. Social Security and Medicare, often denigrated as "transfers of wealth to the elderly," not only benefit the elderly - they save kids and grandkids lots of money and take them off the hook for tough financial and ethical decisions regarding their aging parents. But that's another story.
So, there is all this chatter about federal deficits and "excessive government spending." Actually, deficits are more the result of recession than increased government spending but that, too, is another story. If we need the revenue to help reduce federal deficits, how can the tax code be "reformed" to maintain revenue while lowering tax rates?
The glib, and disingenuous, answer we are given is to reduce or eliminate all those "unnecessary deductions" - read loopholes.
Let me remain a minority of one, or at least the devil's advocate. If the whole effort of "tax reform" is to remain revenue neutral, that is, generate the same amount of revenue as before, why bother? I am not convinced, first, that the average or median tax payer would be better off with lower rates and a tax code with fewer deductions and, second, that it can even come about. Here's why.
Every "unnecessary loophole" is to somebody else an absolutely essential socially beneficial deduction.
The IRS writes the rules. But the rules are under aegis of laws passed by the Congress - politicians, elected by voters in elections financed largely by wealthy interest groups that expect consideration for their largesse. Every deduction, credit, or "loophole" in that tax code is there because some group lobbied to put it there. Does anyone really think those people who put it there will stand idly by while it is attempted to be removed?
Of course some of those deductions are popular with many citizens. The mortgage interest deduction comes to mind. Even if the leverage of the individual citizen acting alone is limited, the influence of the real estate industry is huge. The point is that, given the way our political system functions, the odds of significantly reducing the credits and deductions in a way that generates significant additional revenue are very, very slim. And even if some of these tax advantages were removed, I'll give you one Congressional session, and most of them would be right back in the code.
In any serious effort at "tax reform," we will see lobbying and money thrown around like nothing we have seen before. So here's why it's time to run for the hills - well maybe not quit - but why it's time to worry when politicians talk about "tax reform."
Make no mistake about it - it takes money, and lots of it, to get elected to Congress. And people who have the money for lobbying and campaign contributions have direct access to politicians writing the multiple complex and obscure rules of the tax code. Any significant changes to the tax code are not likely to benefit the typical middle income, even upper middle income, and for sure, the lower income citizen.
Even changes that most citizens would agree on have tough sledding. Most people would agree that the "carried interest" provision that allows multi-million dollar incomes of hedge fund managers to be taxed at the preferable capital gains rate instead of the higher marginal rate paid by the rest of us should be changed. That proposed change got nowhere in Congress. It doesn't take a political scientist to figure out why.
A simple tax code is an illusion - a pipedream. Lower rates in exchange for unspecified removal of deductions? Sure, as long as those deductions are at the expense of somebody else. But in the aggregate, that is mathematically, not to mention politically, impossible.
It all sounds marvelous and painless - a simpler code, lower taxes, even as the system is promised to generate as much revenue as prior to "reform."
I cringe when politicians talk of tax reform. Given this Congress and the political system driven by money, I would just as soon they drop the subject.
As a minority of one, I prefer to stick with the devil I know.
- John Waelti of Monroe can be reached at jjwaelti1@tds.net. His column appears each Friday in The Monroe Times. He is a retired professor of economics.
We all complain about the complexity of the tax code. But let's face it - some of it is essential - business expenses, for example. Whether for large corporations, partnerships, limited liability corporations, or "mom and pop" operations, there must be guidelines and rules for determining legitimate expenses. Durable assets must be expensed over time. We can quibble about the rate and matters such as accelerated depreciation. But economically rational rules and sound accounting practice necessarily complicate tax codes to some extent.
There is the more controversial matter of credits and deductions in the tax code. This brings us to the philosophical issue of whether taxes should have the sole purpose of raising revenue or should intentionally be used also to influence behavior. For example, higher taxes on cigarettes raise revenue but also discourage smoking.
Deductions that reduce taxable income, and credits that directly reduce taxes owed, influence behavior. For example, the deduction for mortgage interest encourages home ownership, a generally accepted social goal. Tax credits for purchase of energy-efficient equipment are designed to save energy, another generally accepted social goal.
Here is where the illusions of tax reform come in. Politicians across the political spectrum take as given that it would be a good thing to reduce rates for federal income taxes across the board. After all, everyone would like a reduced tax bill, especially if there were no reductions in government services on which, admit it or not, we all depend. Social Security and Medicare, often denigrated as "transfers of wealth to the elderly," not only benefit the elderly - they save kids and grandkids lots of money and take them off the hook for tough financial and ethical decisions regarding their aging parents. But that's another story.
So, there is all this chatter about federal deficits and "excessive government spending." Actually, deficits are more the result of recession than increased government spending but that, too, is another story. If we need the revenue to help reduce federal deficits, how can the tax code be "reformed" to maintain revenue while lowering tax rates?
The glib, and disingenuous, answer we are given is to reduce or eliminate all those "unnecessary deductions" - read loopholes.
Let me remain a minority of one, or at least the devil's advocate. If the whole effort of "tax reform" is to remain revenue neutral, that is, generate the same amount of revenue as before, why bother? I am not convinced, first, that the average or median tax payer would be better off with lower rates and a tax code with fewer deductions and, second, that it can even come about. Here's why.
Every "unnecessary loophole" is to somebody else an absolutely essential socially beneficial deduction.
The IRS writes the rules. But the rules are under aegis of laws passed by the Congress - politicians, elected by voters in elections financed largely by wealthy interest groups that expect consideration for their largesse. Every deduction, credit, or "loophole" in that tax code is there because some group lobbied to put it there. Does anyone really think those people who put it there will stand idly by while it is attempted to be removed?
Of course some of those deductions are popular with many citizens. The mortgage interest deduction comes to mind. Even if the leverage of the individual citizen acting alone is limited, the influence of the real estate industry is huge. The point is that, given the way our political system functions, the odds of significantly reducing the credits and deductions in a way that generates significant additional revenue are very, very slim. And even if some of these tax advantages were removed, I'll give you one Congressional session, and most of them would be right back in the code.
In any serious effort at "tax reform," we will see lobbying and money thrown around like nothing we have seen before. So here's why it's time to run for the hills - well maybe not quit - but why it's time to worry when politicians talk about "tax reform."
Make no mistake about it - it takes money, and lots of it, to get elected to Congress. And people who have the money for lobbying and campaign contributions have direct access to politicians writing the multiple complex and obscure rules of the tax code. Any significant changes to the tax code are not likely to benefit the typical middle income, even upper middle income, and for sure, the lower income citizen.
Even changes that most citizens would agree on have tough sledding. Most people would agree that the "carried interest" provision that allows multi-million dollar incomes of hedge fund managers to be taxed at the preferable capital gains rate instead of the higher marginal rate paid by the rest of us should be changed. That proposed change got nowhere in Congress. It doesn't take a political scientist to figure out why.
A simple tax code is an illusion - a pipedream. Lower rates in exchange for unspecified removal of deductions? Sure, as long as those deductions are at the expense of somebody else. But in the aggregate, that is mathematically, not to mention politically, impossible.
It all sounds marvelous and painless - a simpler code, lower taxes, even as the system is promised to generate as much revenue as prior to "reform."
I cringe when politicians talk of tax reform. Given this Congress and the political system driven by money, I would just as soon they drop the subject.
As a minority of one, I prefer to stick with the devil I know.
- John Waelti of Monroe can be reached at jjwaelti1@tds.net. His column appears each Friday in The Monroe Times. He is a retired professor of economics.
