Progress Short of Postcards
Jake Brodsky, Dartmouth Business Journal
The Tax Cuts and Jobs Act, passed along party lines by Congress and signed into law by President Donald Trump in December 2017, marks the most expansive overhaul to the tax code since the Reagan era. Economic conservatives could not have asked for a better Christmas gift, as they celebrated the tax bill’s inclusion of slashes to the corporate tax rate, widespread lower income taxes and a variety of deregulatory and financial perks for small and large businesses across most industries. However, people yearning for the delivery of a central promise of the bill are left wanting; while elements of the byzantine tax code were simplified by the new bill’s passage, the system remains essentially as complex as ever.
The reality is Americans in 2018 will not be able to do their taxes “on a postcard,” a colloquialism used by Senate Majority Leader Mitch McConnell and Trump, which referred to the optimistic idea that tax-payers would no longer need to fill out – or pay someone to fill out – hundreds of sheets and documents for the IRS each year before Tax Day. The failure to streamline the tax system begs the question of whether Americans will ever see simpler procedures, or if they should accept that today’s economy is too complex and the influence of special interest groups too strong for itemized deductions to ever fully disappear.
The history of the federal tax system is one of sustained growth, both in regards to the number of citizens targeted and the size of the bureaucratic skeleton. Throughout the 20th century, tax rates and the number of deductions ballooned. Before World War II, only a small percentage of the wealthiest Americans paid taxes; that number, about seven percent, expanded to include nearly 70 percent of the population while the war was being funded, according to economic website Marketplace. Due to the introduction of the Earned-Income Tax Credit (EITC), a refundable tax credit for low income people (especially those with children), this number has declined to 53 percent of the population that pay taxes today. As a result, changes to the federal tax code mostly affect non-retired earners who do not qualify for credit breaks.
The new bill also doubles the standard deduction for these non-retired earners, which admittedly promotes more simplicity as an increased amount of people will be incentivized to deduct a flat rate rather than itemizing deductions line by line. Most people who have the opportunity would evidently rather pay a clear flat rate than suffer through an endless sea of forms and painstakingly account for their receipts. Internal Revenue Service (IRS) data from 2013 (the most recent year with available data published) shows that 68.5 percent of households took the standard deduction in lieu of line by line deductions, leaving only 30.1 percent of households that choose to itemize. This latter number will shrink as a result of the tax bill, but for those that continue to itemize, the system will likely continue to be as convoluted as it was last year.
One of the tax system’s central controversies has repeatedly been individuals exploiting technicalities in tax breaks for certain behaviors, in an effort to avoid paying taxes. One example of this involves businesses shifting their official classifications from an industry such as “Consulting” to a less-taxed industry, in order to keep more of their revenue. Since certain new rules implemented by the Tax Cuts and Jobs Act are intended to simplify parts of the code, there will inevitably be situations where people will attempt to cheat the IRS by taking advantage of loopholes that reward certain types of behavior.
For example, an important provision in the new bill increases the deduction for pass-through entities, which are business vehicles exempt from corporate income tax such as landlords’ real-estate, legal partnerships and S-corporations. According to the Brookings Institute, however, 95 percent of all U.S. businesses can be defined as pass-throughs. While this particular change will be a boon for many small businesses and may spur economic growth, the reality remains that the majority of this pass-through income flows to the top one percent of earners, who might try and position themselves as businesses rather than as individual taxpayers in order to pay a lower rate. For example, a hedge fund might absorb hundreds of millions of dollars a year and still classify as a pass-through based on the status of its ownership, which may seem unfair to earners making less but proportionally paying more. In turn, more rules would have to be put in place to prevent this disingenuous behavior from occurring, leading to more provisions, more paperwork and more bureaucracy.
Similarly, while the bill lowers most individual rates, it also keeps the previous seven income brackets in place. As was the case in the previous tax code, the amount of income paid scales up gradually. For example, a family with an income requiring a 28 percent income tax rate will not pay a full 28 percent of its income to the IRS. Instead, for its income that falls within the first income bracket, the family would be taxed at the 10 percent rate stipulated by the new bill. This taxing procedure would continue for its income falling within the subsequent income brackets (rates of 15 percent, then 25 percent), and finally the remainder of its untaxed income will be taxed at 28 percent. This is just one more cause of confusion and frustration that the bill did little to eliminate.
Several solutions to tackle the complexity of the current taxing system have long been brought up by experts. One solution is that of investor Steven Forbes, who has always advocated for a flat tax system with no deductions or loopholes. This radical solution would eliminate the interest group question entirely and make tax filing truly doable on a postcard, although inevitably resulting in a loss of benefits for the poor and elderly. However, the idea never gained much real traction during the process of amending the bill. Instead, the debates over what changes to make to the existing code centered around haggling over individual bracket rates, debates over which deductions to add or eliminate and a variety of other minutia that was decided by different Congressmen and committees. A different path towards simplification, and the one that was most used in practice, is the elimination of as many itemizations as possible. However, most discussions of removing specific line items faced pushback from one interest group or another.
Approaching the tax system by attacking line-by-line details parallels the myth of Hercules and the Hydra: cutting off one head of the beast leads to two more popping up in its place. For a meaningful simplification of the tax code to take place, politicians will likely have to start working on a bill from the top down with the philosophy that all itemizations must go and that flat taxes will be the new standard for each income group. If they can accomplish this while maintaining a safety net for low-income and elderly people, all families and earners will benefit. Until then, per the Taxpayer Advocate Service, Americans will continue spending a combined six billion hours a year filing taxes while paying compliance costs roughly totaling 195 billion dollars. There’s a reason tax magnate H & R Block’s stock actually increased after the bill passed, despite early fears the company would be forced to close its doors. The Tax Cuts and Jobs Act made some meaningful strides by doubling the standard deduction, but the code still has a long way to go before filing taxes on a postcard becomes possible.