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Thursday, April 14, 2011

Why is the tax law complicated?

In trying, for my own benefit (and a future article), to identify the reasons for complexity, I come up with these:

  • Too many provisions. There are multiple tax relief measures with similar purposes. For example, family measures (head-of-household filing status, dependent deduction, child care credit, child credit, EITC), education, retirement, mileage rates, depreciation, and more.

  • Using the tax law to remedy all problems. For example, subsidizing higher education costs for families and individuals, encouraging green behavior, and much more. Adding new provisions without removing any old provisions.

  • Trying to make the law more progressive or less regressive without changing the tax rate or tax rate structure. For example, phase-outs, partially refundable credits for some individuals (such as child credit and Amercian Opportunity Tax Credit).

  • Using the same word but with different meanings. For example, phase-out, modified adjusted gross income (a term used for most phase-out rules, but not always defined the same way), child, small, and others.

  • Ignoring existing rules. For example, odd due date rule for FBAR (June 30), creating a child credit rather than increasing the dependent deduction, and more.

  • Overly complicated approaches to prevent possible abuses. Examples – kiddie tax, AMT, among others.

  • Desire for accuracy. For example – not excluding small amounts of cancellation of debt income, the "kiddie tax" calculation, and others.

  • Having two parallel tax systems. We have both a regular tax system and the AMT, rather than reducing or cutting back the number of tax deductions, exemptions and credits. (Please see my December 2007 op ed in the Business Journal for why the AMT should be repealed.)

  • Budget related problems. For example, temporary provisions that are continually renewed because to make them permanent costs too much in a ten-year budget projection and a single bill that needs to be revenue neutral (more spending cuts or tax increases would be needed in the bill to make the provisions permanent).

What do you think?


Peter Reilly said...

Taxing income as opposed to gross receipts has a level of inherent complexity. What are ordinary and necessary business expenses, timing of income and deductions and who's income is it really ? I think that is where the irreducible complexity lies.

Professor Nellen said...

Peter - thanks for pointing out another reason for complexity. Some tax bases are just difficult. That could also be true for a property tax based on current market value which can be difficult and time consuming to measure. Better to use something like California does and limit the annual increases to a specified percentage and use sales data to revalue upon property transfers.

Of course, gross receipts will have a few difficulties perhaps with respect to foreign transactions as companies would try to move investment assets outside of the US so the income doesn't go into US gross receipts. Similar issues occur in state taxation. But rules could address that and in terms of all taxpayers, that is a small percentage with that issue.

Thanks for reading and the comment!

Stephanie Corwin - SJSU said...

There are several factors that contribute to the complexity of the tax law. As you mentioned, as the government decides to “remedy all problems” with the tax law, it adds complexity. There are a high number of tax deductions and credits aimed at incentivizing higher education and retirement savings. All 11 of the education and retirement savings incentives alone add to the complexity of the tax law.

The Earned Income Tax Credit (EITC) is another credit aimed at remedying a problem that instead adds complexity to the law. Many low income taxpayers hire a tax professional to file their return for the EITC alone.

As you mentioned above, the alternative minimum tax (AMT) has exceeded the original purpose of closing loopholes of wealthy taxpayers. Now it requires all taxpayers to calculate their tax liability twice and can encompass a wider range of taxpayers than originally intended.

These are a handful of the complexities that currently exist in the tax system.