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Wednesday, April 11, 2012

Bartlett & Johnston: Real Tax Reform -- Eliminate 100 Million Unnecessary Returns

This week millions of Americans will be rushing to calculate and file their income taxes — and probably cursing whoever invented this confusing, complicated monstrosity.

Many people will spend money on accountants, tax software or storefront tax-preparation services. The cost in terms of time alone runs to the tens of billions of dollars, with billions more spent out of pocket. The aggravation factor is beyond calculation.

Politicians often rail against the complexity of the tax system as the key source of taxpayer frustration. Historically, however, voters have been unwilling to support meaningful simplification efforts and happily put up with complexity if it saves them in taxes. They seem always to fear that “simplification” is some sort of code word for raising their taxes while reducing someone else’s.

Another barrier to simplification is a loss of privacy. In 2003, the Treasury Department put forward a proposal to create a return-free tax system for most taxpayers, as many other countries have. In essence, the IRS would calculate your taxes for you and send you a bill or a refund. The Treasury proposal went nowhere, for two reasons.

First, reporting of income and tax withholding would have to increase to provide the IRS with the data needed to accurately calculate people’s taxes. But people have been highly resistant to additional withholding; a law requiring it on interest income was enacted in 1982 but almost immediately repealed after widespread complaints.

The second problem is that the tax system would have to be radically simplified to allow the return-free system to operate. Radical simplification sounds nice in theory; just wipe the slate clean and start from scratch. ... Talk is cheap when it comes to eliminating tax expenditures, but when it comes to actually naming specific preferences that would be eliminated, few are willing to step up to the plate. Politicians hide behind grandiose plans for wiping the slate clean because they know that support for every specific tax expenditure is very high. In practice, saying that one would eliminate all tax expenditures is meaningless, nothing more than a gesture that avoids confrontation with the constituencies supporting tax expenditures. ...

So how do we get out of this mess? One idea is to do what Gen. Douglas MacArthur did during World War II — bypass enemy strongholds, leaving them isolated and relatively harmless.

Prof. Michael Graetz of Columbia Law School has proposed what I believe is a MacArthur-like solution to tax reform. He would abolish the income tax for the vast bulk of Americans and replace the revenue with a 12.5% value-added tax. People would pay their taxes when they buy things and wouldn’t need to worry about keeping records or filing tax returns at all.

The brilliance of the Graetz plan is that no tax expenditures need to be repealed. He would simply give every family a tax exemption of $100,000, which would eliminate the income tax for 90% of those now filing returns. For lower-income people who currently have no net income tax burden or who earn an income tax credit, Professor Graetz proposes a rebate (too complex in its details to spell out here). ...

Professor Graetz first laid out his plan in a 2002 Yale Law Journal article, which was expanded into a book in 2007, “100 Million Unnecessary Returns.” A popular explanation of his plan appeared in the November/December issue of The American Interest, and a detailed analysis by the Tax Policy Center was published in January.

I think this is a viable proposal that ought to be the starting point for a real debate on tax reform.

Congress could easily eliminate fraud by abusive tax preparers ... and save taxpayers billions of dollars annually, by simply ending mandatory filing of tax returns for most taxpayers.

About 100 million taxpayers — those whose income is entirely from wages and retirement funds, and who do not itemize deductions — should not have to file returns. The government already has the information it needs to calculate the taxes these people owe, once they supply their marital status and number of dependents. It would not take much to automate their income tax payments, as many other modern countries do. ...

Congress will not act because individual income tax returns, which for most people are make-work that creates a drag on the economy, provide tidy revenues for Intuit, the maker of TurboTax software, H&R Block and other legitimate corporations that profit from preparing tax returns. These companies have considerable resources at their disposal to spend on lobbying politicians to keep the tax filing requirement. One sign of their determination: Intuit in 2006 donated $1 million in support of an unsuccessful candidate for California state controller who opposed optional state-prepared returns in California. Intuit has said there are serious problems with the program, which remains in operation, but in my view none of Intuit’s criticisms stands up to scrutiny.

Intuit, H&R Block and other tax firms say that they help people pay the least tax and avoid costly mistakes. But these concerns would be easily addressed by simplifying the tax code. In my view, any business that depends on government-induced inefficiency should be swept into the dustbin of history.

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Comments

Hold onto your wallets when two left-wingers suggest letting the government prepare your tax returns for you and decide what you should pay them.

And, it's hilarious when Bartlett forwards as another alternative what is essentially the Flat Tax. Maybe he likes the 9-9-9 Plan, as well.

Then, too, it's a little disingenuous when Johnston implies that tax preparers are somehow scamming the system for business rather than responding to a need created by the complexity of the tax code established by government.

So, whenever government creates a problem, what do liberals say? "We need more government to fix it." What could go wrong?

Posted by: Woody | Apr 11, 2012 8:37:29 AM

@ Woody,

I have consistently written against complexity, twofers, and the AMT.

As my column notes, for people with only labor income that is verified all the IRS needs is marital status and dependents. People who use the California ReadyReturn love it. Other countries do this.

With small changes (see previous columns) we could encourage people to save and still eliminate tax filing. How? Make a small amount of capital income tax-free since most people have none to little.

How about a constructive post, unless, of course, you favor continuing a needless drag on the economy for the large majority who do not itemize.

Posted by: David Cay Johnston | Apr 11, 2012 2:07:32 PM