The complexity of completing one's federal and state income tax returns is not necessarily tied to one's income level. One of the more complex federal tax rules is the Earned Income Tax Credit (EITC) for low-income workers. Could the individual income tax be simpler? Yes. Here are some ideas.
- Make all income you received subject to tax. What is income? Let's say it is anything that increases your wealth. So, it would be any payment from the government, debt forgiveness, gross wages, employer-provided health insurance, scholarships, gains from selling assets, etc. What would not be income? Borrowing money (it does not increase your wealth because you have an offsetting liability). Receipt of expense reimbursements from your employer (it makes you whole for what you, in essence loaned to your employer when you incurred the expense). The simplification comes from not needed to determine if something you received is taxable; generally, it would be.
- Allow very few non-business deductions. It should just be personal and dependency exemptions that, in effect, remove from your income what it takes to live. The rationale is that you need some portion of your income to live and it should not be available for paying taxes. The amount should be tied to some multiple of the poverty level based on family size and your address to reflect that it costs more to live in some parts of the U.S.
- Allow business deductions including an inflation-adjusted expensing amount (Section 179) that would provide simplification and incentives to small to medium sized businesses. Expensing should apply to both tangible and intangible personal property.
- Address equity issues with simple rules. For example, the state condemns your personal or business property resulting in you realizing a gain. But, you want to (or need to) buy replacement property. If you have to pay tax on the gain, you may not have enough for replacement property. So, keep a simplified Section 1033 on involuntary conversions that allows for gain deferral. Perhaps also allow for deferral of cancellation of debt income for insolvency or bankruptcy (to help with a fresh start for the person). The balance of the current, lengthy and complex cancellation of debt income exclusion rules could be removed. Others? There will be situations where someone has had some unusual, bad, expensive event, such as a casualty or large medical expense, that prevents them from having sufficient funds to pay their income tax. Some simple, limited rules for these types of events should be provided. We'd also need simple rules to ensure that income earned outside of the U.S. was not taxed by two countries. A foreign tax credit not to exceed what the U.S. tax on the income would be should work.
- Retirement plans and savings - this is a bit more challenging. Individuals should be saving for their retirement. The money you put into your retirement is money not available for paying taxes. Also, if you pay tax on the income when earned and again when withdrawn, that doesn't seem fair (except for what you pay on the income earned while the money was in the retirement account). Also, lower income individuals will need an incentive to fund a retirement account due to limited funds. So, should they get a deduction for putting funds in a retirement account? Retirement rules is an area of our tax law in need of significant reform. The current rules primarily benefit higher income individuals as they can take better advantage of the rules. The rules are also complex due to the number of different types of retirement plans.
- Education incentives - today there are at multiple, duplicative, complex provisions offering various tax savings for higher education costs. I think that for the most part, this should all be taken care of outside of the tax law because there is already a system in place, such as for Pell Grants. When these rules are brought into the tax law, they primarily benefit those with enough income to owe tax - individuals who likely don't qualify for Pell Grants. But, what about my earlier point that the student receiving the scholarship will include it in income? Should they get some tax relief? Or should we expect them to work to get the money to pay tax on the scholarship or seek a gift from family and friends? Perhaps some version of the current American Opportunity Tax Credit (AOTC) should remain. It would also help the student without a scholarship or Pell Grant who is working to pay for tuition. It would not need to be refundable because once your tax is down to zero due to your personal exemption, you are not paying tax on the scholarship. Tax rules for higher education also need attention for simplification and equity issues. For example, the current AOTC is for the first 4 years of college, providing a maximum annual credit of $2,500. That has differing results for these two students: (1) Ann who attends a private university for 4 years; gets a $10,000 benefit from the government. (2) Barbara who attends community college for 3 years where the annual tuition is less than the AOTC amount so she doesn't get full benefit of the credit and then she attends public university for 3 years to complete her degree and where the tuition is higher. Her total benefit is less than $10,000. This needs to get fixed.
- Other changes?
- Lower tax rates to reflect that the tax base is larger with the above changes. With lower tax rates, capital gains should be taxed at those same rates.
- The net investment income tax (3.8% Medicare tax for high income individuals) should be repealed (an adequately progressive income tax rate structure would take care of it).
- AMT should be repealed because there should be only one minimum tax and removal of most of the special deductions, exclusions and credits would leave no need for it.
- Some replacement should be made for the current income exclusion for state and local bond interest income. This exclusion benefits higher income individuals who buy the bonds and it helps state and local governments. Whatever the average annual "cost" to the government has been for the exclusion for the past five years should become a fund that the federal government would make available to state and local governments to replace the lost benefit of the exclusion. And add the caveat that they can only get the funds if they conform their state income tax to the new, simplified federal income tax system (to better ensure true simplification for individuals).
- More simplification such as fewer penalties and clearer rules on worker classification.
What do you think?
1 comment:
I agree completely, Annette! Each year I am shocked how complicated filling out my taxes is, even as a highly educated person, with a law degree, and a relatively simple tax situation.
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