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Moving Lips

TAX RELIEF - There’s the saying: How do you know when a politician is lying? His or her lips are moving.

That’s not quite true.
It’s a lie when the politician’s lips are moving and forming the words tax reform or tax relief.
Legislators or candidates who promise either are pandering for votes.

The Internal Revenue Code is beyond reform; it is foolish to make an attempt given the barriers created by the sheer complexity of the code and the influence of interest groups from almost every sector of society and industry.

It is easy to promise fairness and relief through reform when relatively few are familiar with the content of the Code.  

To paraphrase a few lines from one of  Les Miserable’s most popular scenes:

Rules beyond compare,
rules beyond belief!
Put them altogether
and call it tax relief!

We are as bamboozled as Thenardier’s guests when it comes to taxes.

It was pure chutzpah that the Congressional action which created the current version of the Internal Revenue Code was named the Tax Reform Act of 1986. Maybe it was reform in the Bizarro world.

In my view, about the only good that came out of it was the consolidation of tax brackets from fifteen to five.  That much made it a little easier for the average person to plan what they might owe to the federal government, but many people still couldn’t tell if they were measurably better off or worse than in prior years. Comparing your taxes from one year to the next is an apples to oranges affair under stable conditions; attempting it when the rules have been overhauled is more like water to dirt, unless you want to pay a professional to figure it out.

Taxpayers were still left with a Byzantine system after 1986 and unsure if the changes offered any relief….and there was certainly no relief when it came to preparing returns.

Changes have been made since 1986, some of them substantial (such as the Bush tax cuts) but the structure has been virtually untouched….and that feeds the rage people have expressed over the fairness of the system.

Arguments over who is or is not shouldering a fair share are based more on emotion than facts. It is not anywhere near as simple as the 99% versus 1% as the Occupy Everything movement insists .
It’s not that there isn’t unfairness - indeed there is – but unfairness transcends most income levels.  

Two households with the same income can have tax liabilities that are as different as night and day within any bracket.

The alternative minimum tax (AMT) is one of the best examples of the Code’s obfuscation. Originally designed to reel in 155 wealthy Americans who did not pay a dime of tax, it has now grown to where 27% of households earning under $200,000 paid it. The AMT is a parallel tax system that most taxpayers must calculate, even those with average incomes, to assure they are in compliance with the law.

Fortunately, readily available tax software does the calculation for you, but it does not prevent a nasty surprise when you learn you owe more than anticipated.  A taxpayer may have made all the right decisions throughout the year to minimize taxes only to discover that many deductions they were counting on are wiped out in the other universe of the AMT.

Yet, we put up with this chicanery. People just roll over and allow their federal legislators to perpetuate it, allowing themselves to be strung along with false promises of tax reform.
Do you know what kind of “tax reform” is on the table?

The elimination of the mortgage interest deduction, for one thing!

Now, I could support that if it were part of a wholesale conversion to a flat tax system along the lines of what Steve Forbes suggested years ago.

Unfortunately, Forbes also got excited over Texas Governor Rick Perry’s flat tax plan. If something like it were implemented, it would mean suffering through three methods of tax calculations: regular, AMT and a flat tax. I would hardly call that tax reform.

Herman Cain made some noise with his 9-9-9 concept, but one component – a 9% national sales tax - would have been grossly regressive. If you turn 9-9-9 upside down, you get 6-6-6. If you ever watched The Omen, you know what that means.

Fortunately, both Cain and Perry are out of the picture as far as the Presidency is concerned.
But they succeeded in giving the concept of a flat tax a black eye.  Many people are not going to think beyond the flawed ideas they proposed.

Let’s clarify one thing before going further – all flat tax proposals, including Forbes’, is at least moderately progressive. What makes it so is setting an income level below which nothing is taxed - a zero tax bracket.

Say every penny of income up through $35,000 were not taxed; everything above it taxed at 15%. A filer earning 35,000 would owe nothing; an income of $50,000 would pay an effective rate of 4.5%; $500,000 would bear a 13.95% effective rate.

There would also be no deductions, credits, personal exemptions nor preferences in the purest flat tax plan – and no AMT.

Notice I said “in the purest flat tax plan.”

We are not going to see that until pigs fly, the cows come home and hell freezes over.  There are compromises that will have to be made, but we could still have a Code that would take less space than a chapter in a Dan Brown novel….and a tax return on a 5×7 postcard for almost everyone.

Only individuals who never made it past third grade math would require preparation assistance.  Even those people would be able to avail themselves of free help from the IRS.

The simplicity would offer a number of benefits: almost no preparation time; no anxiety; no preparation fees; easy tax planning.

The government would benefit as well: more reliable revenue projections; less costly administration; more time for Congress to address meaningful issues.

Potentially, a flat tax could translate to more revenue for the government.  IRS agents would be far more productive chasing down the individuals responsible for the annual tax gap instead of enforcing arcane rules that they themselves may not understand (the confusion over whether airline miles are taxable [link] is a recent example of the limbo facing many citizens).

The latest estimate for the tax gap - the difference between the aggregate tax liability and the actual revenue collected – grew to $385 billion in 2006, up from $290 billion in 2001 (the data used for these estimates lag, which is why 2006 is the latest year evaluated). By the way, those amounts are per year.  Just do the math to estimate the cumulative impact, if you dare, and imagine what it means to the federal deficit.

Instead, IRS agents are spending too much time determining if a taxpayer was using the right depreciation method or was eligible for the earned income tax credit, or enforcing other useless rules with questionable economic value.

It won’t be an easy task to close the tax gap in any event, but the odds would be much better if the IRS could focus on the population segments with the greatest risk of non compliance. There are data riches to be mined that would give clues to whether some people were playing  fast and loose with revenue reporting, but the resources needed to do perform the analysis are inadequate and preoccupied with enforcing the current Code.

Congress would have to change its mindset on the objectives of a tax system before we could move forward with a flat tax system.

Rather than using the code as a means of social engineering, economic stimulation and revenue generation, drop the first two (they have failed us) and focus on a system that raises adequate revenue in a fair and understandable manner.

(Paul Hatfield is a CPA and serves as Treasurer for the Neighborhood Council Valley Village.  He blogs at Village to Village, contributes to CityWatch and can be reached at: –cw

Tags: Paul Hatfield, IRS, Internal Revenue, taxes, income taxes, flat taxes

Vol 10 Issue 11
Pub: Feb 7, 2012