“Abolish the IRS” Distracts from Needed Reforms

Republican presidential candidates Senators Ted Cruz and Mike Huckabee would like to abolish the IRS. They are not saying they want to abolish taxes, just the agency that collects them. Even if either is able to simplify taxes to the point that no taxpayers have questions or need guidance, we still need a tax collector, as well as an auditor to ensure compliance.

A call to abolish the IRS is a distraction. That’s too bad because there are significant improvements needed to our federal tax system – a system that includes not only the income tax, but also employment, excise and estate and gift taxes.  Tax reform must be the focal point, not termination of the entity that collects revenues to fund schools and roads, provide national defense, and much more.

The IRS is an easy scapegoat for complaints about our tax laws. But those laws come from Congress. Yes, the bills must be signed by the President to become law. But if no tax bill arrives at the President’s desk, no statutory change is possible. For reform, let’s first look to where Senator Cruz resides – Congress.

Reforms are needed. Here are just three examples to illustrate problems in our federal tax system. Resolving these types of problems can enable our tax system to be simpler, more equitable and better promote economic growth.

First, our federal tax system is too complex resulting in excessive compliance costs and errors. According to the IRS National Taxpayer Advocate, businesses and individuals devote over 6 billion hours annually to tax compliance – the equivalent of over 3 million full-time jobs. Examples of this complexity include a 43-page instruction book for Form 1040-EZ and over eight rules for tax benefits for college costs, explained in a 96-page publication from the IRS (Pub. 970).

Second, our tax system is inequitable. For example, for decades, employees have been allowed to exclude the value of employer-paid health insurance from their income, thereby lowering their income and employment taxes.  Employees get this exclusion regardless of income level (and employers deduct what they pay for the health coverage). Starting in 2014, the Affordable Care Act (“Obamacare”) provides a refundable tax credit to individuals without employer-provided health coverage who buy insurance on the exchange (such as Covered California). However, these individuals losethat subsidy if their income exceeds 400% of the federal poverty line ($45,960 for a single person for 2014). 

Take for example, Jane and Sara, each 50 years old, single and having $100,000 of taxable income for 2014. Jane obtains health coverage from work with her employer covering the entire cost of $6,000. Jane is allowed to omit this $6,000 benefit from her taxable income. Sara obtained her insurance from Covered California at a cost of $6,000, paid out of her own pocket. Because Sara’s income exceeds $45,960, she obtains no tax subsidy. Meanwhile, Jane gets a tax subsidy of $1,680 (based on a marginal tax rate of 28%). Sara is out-of-pocket $6,000 while Jane gets a $1,680 subsidy (and has no out-of-pocket costs for health insurance). Why does this inequity exist? This is just one of many tax system inequities where some individuals receive tax reductions while others at similar, or even lower income levels, do not.

Finally, our tax system has not kept up with technology and new business models. Today, most countries only tax businesses on income earned within their borders rather than the U.S. approach of taxing worldwide income. Corporate tax rates in other countries are lower while also supporting R&D on a permanent basis rather than the temporary approach used in the U.S. since 1981. Also, today, any size business likely has international operations yet tax rules can be as complex for small ventures as they are for large companies. And, technology should be used to make tax compliance for most people as easy as ordering goods online.

We need to improve our tax system, focusing on all federal taxes, not just the income tax. Our tax system can be simpler, more equitable and better support today’s ways of living and doing business.  Let’s focus on these important issues and not be distracted by absurd rhetoric about abolishing the tax collector.

More to come - "abolish the IRS" is not the only odd tax reform coming from candidates.

What do you think?