Both the 2008 and the 2012 U.S. presidential elections seemed like a mark that the United States had distinctly changed direction.
But even in the Democratic primaries, the discussion between Hillary Clinton and Barack Obama was of incidental tweaks on policy - nothing grand.
Although the Obama presidency proposed to be an invitation to review new priorities, his presidency has turned out to be mostly Clintonesque “small ball.” Even the Affordable Care Act was incremental in effect - important, but not Medicare for all.
In the area of taxation, that was the case as well. Rather than undertake a comprehensive review of the way people in the United States are taxed, the tax law has barely changed. The George W. Bush–era tax reduction provisions and structures were extended and institutionalized. Even the tax increases of the Affordable Care Act were relatively minor.
Bernie Sanders, thankfully, implies something different. But his proposals and invitation for policy review are grounded in the political conviction of social and economic equality. They are anything but academic.
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Although taxation is a - or the - primary area of class favoritism, the Sanders campaign to date has only spoken of tweaks, of adding additional populist features to an already-overburdened tax code, of closing relatively insignificant loopholes.
The ability of large corporations to defer taxation by off-shoring profits is aggravating. But reforming that situation does not significantly fund the federal government, nor does it change the class favoritism inherent in the tax code.
Bernie Sanders has not suggested a thorough review of tax structure. If he wants the progressive professional accountants of the world to regard him seriously, he needs to. I and others fear that he will also undertake Clintonesque “small ball” in this most critical policy area.
The tax system is broken, and it needs to be reviewed thoroughly. A tweak when a system is non-functional due to excessive complexity actually makes it worse.
What we need is a Copernican reformulation: a new and simpler design.
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What's wrong with the current tax system? What should the tax system do?
• A functional tax system adequately funds government services. Historically, the federal government has been sufficiently funded only during Democratic administrations. During both the Clinton administration (clearly) and the Obama administration (to a lesser extent), tax rates have been high enough relative to federal spending to generate surpluses.
The Republican dogma of reducing taxes to stimulate investment to stimulate economic growth has never borne out, except in very specific circumstances.
Currently, tax rates are still historically low, and government expenditure as a proportion of the Gross Domestic Product is also historically low.
• A functional tax system is comprised of functional law: Understandable and easy to apply, stable and predictable. Because the tax law is so confusing, virtually all individuals earning beyond a simple salary must have a tax professional prepare their tax return, let alone think about the future.
Common citizens do not know what is expected of them or what benefits they are entitled to. Tax law is written in legalese that a minority of citizens understand.
Law that is not understandable is not functional law. Law that requires professional knowledge and counsel over common knowledge of the law is inherently unfair. Further, the tax law has many examples of features that reward behaviors that are punished in other parts of federal law and even in the tax code itself - all a result of its unwieldiness.
The largest complaint of the country's investing and business community about the tax law is not that taxes are too high. The most significant complaint is that the tax law is not stable, that it changes from year to year.
It adds to the risk inherent in making real investment in productive assets and efforts. Socially beneficial investments are delayed until the tax consequences are known, and then they require a higher rate of return to justify that unnecessary risk. (Both Democratic- and Republican-led Congresses change the tax law frequently. They all tweak the code, even those who claim to value the stability and predictability of tax law.)
• A functional tax system is fair. A key criterion of fairness is progressiveness in actual tax rates paid. The more income a person or entity makes, the higher the marginal tax rate should be.
But in modern tax law, that is not the fact for any of the types of entities that are taxed.
For example:
-A self-employed plumber making $80,000 per year (a really good plumber) pays a 25-percent federal tax rate, plus approximately 15 percent in self-employment tax, plus state taxes (40-percent marginal tax rate on every additional dollar of income).
-An employed plumber making $80,000/year pays a 25-percent federal tax rate plus 7.65 percent Social Security/Medicare tax (32.65-percent marginal tax rate on every additional dollar of income).
-An employed executive making $200,000 per year pays a 28-percent federal tax rate plus 7.65 percent Social Security/Medicare tax on the first $118,500, then just over 1.45 percent thereafter (29.45 percent marginal tax rate on every additional dollar of income).
-An investor using primarily inherited wealth to generate over $465,000 in income from dividends and long-term investments in stocks/bond/real estate, pays a maximum of approximately 20 percent federal tax rate, or 15 percent if less than $465,000 income.
Why should the federal government tax working people at nearly double the rate as those who invest? Why should the federal government tax income from work at so much higher a rate than income not from work?
Another example:
-A married person earning less than $75,000 per year, all from qualified dividends, pays no tax. A married person making between $75,000 and $465,000 pays 15-percent tax.
-In contrast, a self-employed plumber making $80,000 per year, paying 40-percent marginal federal tax rates, who takes on all of the risks associated with running his or her business, could incur permanent debt if that business fails, possibly from sickness or an accident. That taxpayer incurs more risk exposure than someone who invests in stocks. That taxpayer actually works but is penalized for doing so.
So much for the lauded Protestant work ethic. If we valued earning income rather than just passively receiving income, we would tax it less than we do unearned income.
Corporations are similar. At $101,000 in net income, a C corporation tax is around 39 percent for each additional dollar of net income. At $350,000 net income and all income thereafter, the tax rate declines to around 34 percent. At $10 million net income, the rate increases to 35 percent.
On the deduction side, an individual who makes $150,000 per year receives a deduction from taxable income that results in 25 percent of the value of retirement savings, while someone who makes $30,000 per year might receive a deduction for 15 percent of the value of his or her retirement contribution.
Why should the federal government subsidize the retirement of a professional more than it does the retirement of a working stiff? Shouldn't it be the other way around?
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And finally:
• A functional tax system is effective at influencing socially productive decisions about money, time, resources. Is ours? That is a very big question.
If the tax law is however regarded as not the place to affect personal behavior, then there is the possibility that the tax code can be retained as simple and structurally fair. But if the tax law is regarded as the place to affect personal and institutional behavior, then the tax law will inevitably be constructed ad hoc, entirely losing sight of the design as a whole, and again grow unwieldy.
Currently, the largest social “good” that the tax law encourages is long-term speculation for gain. Whether that is in stocks, bonds, real estate, private homes, or closely held corporations, the current tax law primarily rewards (punishes least) investment over work and passive investment in pre-existing securities enormously over sole proprietorship for service.
If even investment in new productive assets and efforts were valued, new investment would possibly be taxed at lower rates. That is not the case currently.
I believe that that is an utterly perverse preference, embodied in our law. It discourages work, discourages enterprise for current income, discourages investment in enterprise.
The other major area that the tax law encourages behavior of one activity over another is in the deductions from taxable income that are allowed.
They include three types:
-Deductions from taxable income that reduce W-2 taxable income.
For all three types of deductions, the federal government rewards the behavior of the affluent more than it does the behavior of the working poor, in the form of the government subsidizing at the taxpayer's marginal tax rate.
For example, the federal government functionally pays 25 percent of the health insurance costs of someone making $120,000 per year but only 10 percent of the costs of someone making $25,000 per year, or retirement contributions, or charitable contributions.
Legislatively, deductions from W-2 taxable income (category 1) are the premium cake. They apply to everyone with no income limitation (but again at the taxpayer's marginal rates).
The most significant are the deduction of employee contributions to health insurance coverage, reducing their taxable income and retirement contributions similarly.
The big boys (all in the private health-care corporate food chain, and all in the investment services and management food chain) are the ones that benefit from these very large federal subsidies. They are the most powerful of the powerful. They have all worked and spent hard to achieve those federal subsidies.
-Next are the “above the line” deductions, also in the area of health care, retirement investment, but also colleges and student loans. (Consider that the student loan finance industry is immune from bad debts as well, as there is no bankruptcy relief from student loans.) There are some limitations to the deductibility of these deductions, some driven by income eligibility.
-Itemized deductions next. Health expenditures again. State and local taxes. Home mortgage interest. Charitable contributions (religious, largely).
In all cases, it is the taxpayer who determines how the federal government will effectively be spending taxpayers' money, not the legislature. In the case of charitable contributions, in which the majority of donations are to religious institutions, the charitable contributions deduction is in effect the government funding the religious institutions.
Further, for all the areas that the federal government has afforded preferential tax provisions, there is a social downside.
For example, the mortgage interest deduction does not assist low-income working people in getting into homes, as most are not eligible to itemize and their tax-rate savings is only 10 percent of mortgage interest. It does, however, have the actual effect of increasing the price of homes generally, making it more difficult for a family to purchase a first home or to expand to make room for a growing family.
The same is true for health care, housing, and higher education costs. The deductions do not reduce the cost of those necessities (through the tax benefits) so much as they increase the cost of those necessities in the marketplace.
The conventional wisdom is that deductions are considered legislatively off the table. Too many people believe that they do or believe they might benefit from them (even though most don't).
An advocate for the middle class like Bernie Sanders cannot be seen questioning the usefulness of the mortgage interest deduction, for example.
There is a case to be made for transforming all of the deductions offered to tax credits, that are eligible at all at the same rates. Now is the time to pursue good design rather than appealing populist features. There is a wheel to be reinvented. Taxpayers need law that is understandable, that is consistently and easily enforceable, that encourages work over speculation.
Are you up for it, Bernie?
Or, are we looking at four more years of “small ball”?