Tax Reform is the RX (Fiscal Cliff Part 4)

Congress and the President need to extend all of the prior administration’s tax cuts and do this immediately.  Given the current teetering economy, an increase in dividend, capital gains and income taxes will only reduce consumer disposable income and harm the economy. 

For this piece, however, let’s begin reform of the tax code ….

A mention of “tax reform” yields unsolicited, one-dimensional nostrums that you could easily have pulled from a fortune cookie; “broaden the base,” “lower the rates,” “make it simpler,” and “soak the rich.”  But reform to the tax code should be driven by the central goal of improving its ability to pay the government’s bills. 

Over the decades we bent the tax code to accomplish other goals, e.g. limit government spending, give extra income to the poor, fund churches and schools, create construction jobs, boost capital goods sales, promote stylish energy sources, and help quaint farms.  Each blatant boondoggle is someone’s “brilliant policy” and vote-getter.  They need to be removed from the tax code.  Government spending needs to be placed on a sensible trajectory, out in the open.

Our current tax code is an intentional cause of class-warfare – almost one-half of Americans pay no income tax.  Tax code compliance is an economic drag costing $135-$431 billion per year, and the quirkiness of the code makes it an unproductive factor in corporate and retirement planning.  Tax evasion costs another $290 billion per year.

From a consumer’s point of view, effectiveness in funding government spending must be the primary objective.  Fairness must be a close second with three important themes: all must pay at least something toward the burden of the government we have chosen; there must be obvious income-related progressivity in our contributions; and every income source must be taxable. 

For the first time all sources of income should be treated the same way; wages, salaries, gambling profits, gratuities, dividends, realized capital gains (incl. residential real estate), net rents, interest received, barter gains, social security, pensions, and cash value of earned income tax credits, food stamps, health plan subsidies (incl. Medicare and Medicaid), housing subsidies, and inheritances.  Capital gains and inheritances may need to be spread through 5-10 tax years.  This approach taxes everyone’s income more fairly than pretending some kinds of income don’t count.  Besides, the broadened base will allow for lower rates.   

The main deductions on IRS 1040 Schedule A are:  state and local tax (avoids double taxing), mortgage interest (a construction industry sop), charitable contributions, and casualty loss and catastrophic medical costs (safety net components).  Double tax avoidance and the safety net will likely survive, but the mortgage and charitable deductions are on many reformers’ chopping block.  Likewise, employer-paid medical and retirement plan contributions may become taxable. These are expensive ($0.75 Trillion for the period 2012-2020) examples of “tax expenditures” (a cynical label revealing the delusion that your income is the government’s even before it is taken from you under duress). 

Tax reform is coming.  If done with wisdom, it can spur economic growth and a much needed improvement in national unity.  If it’s done over years of protracted sniping and threats, it will damage growth and deepen the class-warfare disease we’ve suffered for 4 years.

Alan Daley is a retired businessman living in Colorado and following public policy from the consumer’s perspective.

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