The Clean Slate

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TOO TIMID?

 

By Keith Libbey and Evan Thomas

 

 

Summary:  If we eliminate all Tax Expenditures, then we can cut rates by 25% and we can eliminate tax returns for all individuals.  Instead, individual taxes can be collected by withholding. This is The Clean Slate system and it is revenue neutral.

 

1.            The Problem.

 

Tax reform is the order of the day.  President Obama has said, “We’ve got to have tax reform.”  Administration officials have said, “The objective is to rid the code of its complex buildup of deductions, credits and exemptions, thereby broadening the base of taxes collected and allowing for lower rates…” NY Times, December 10, 2010, at A1.

 

Taxpayers spend 6.1 Billion hours per year filing their tax returns according to the 2010 Annual Report to Congress, National Taxpayer Advocate (the “Taxpayer Advocate”), p.2.  The complexity of the Internal Revenue Code was decried by the Report on Tax Reform Options:  Simplification, Compliance, and Corporate Taxation (the Volcker Commission).  Their report said that the Code has been amended 15,000 times since 1986 (at p.3).  The Taxpayer Advocate reported that no one can agree on how long the Code actually is.

 

These reports and many others have correctly identified the source of the problem:  the thousands of deductions, exclusions, credits and exemptions (“Tax Expenditures”) in the Code require the filing of millions of individual paper returns by 130 million taxpayers.

 

2.            The Timid Solution.

 

Having correctly identified the problem as the Tax Expenditures in the Code, many reform proposals do not go far enough.  They propose to tinker with the existing system, leaving taxpayers to continue filing returns and trying to figure out all of the new provisions and the changes that will always be coming.  Everyone agrees that the present system is terrible, but many proposals fail to offer a real solution.  If the problem is the system of Tax Expenditures, isn’t the solution to eliminate them?

 

3.            The Real Solution—The Clean Slate.

 

We need a Clean Slate: elimination of all Tax Expenditures would clear the way to collect all individual taxes by withholding taxes at the source; a “pay as you go” system.  The Clean Slate wipes out all Tax Expenditures and establishes a withholding system through the existing electronic payment system.

 

Services like ADP, Ceridian and others now collect and pay much of the withholding, payroll, Medicare and related taxes, along with 401k and other retirement contributions. These payroll services are fully equipped to deal with the tax code and its changes very efficiently. Their tax experts make the necessary changes for millions of taxpayers instead of each taxpayer needing their own tax expert.  They could be part of the overall withholding system, along with banks, brokers, credit card companies and employers.

 

4.            A 25% Cut in Tax Rates.

 

The Clean Slate allows income and payroll tax rates to be cut by 25%.  Elimination of Tax Expenditures and a 25% tax rate cut would be revenue neutral.  AMT would be eliminated. 

 

Married Filing Jointly – 2010

Married Filing Jointly – Clean Slate

Bracket Amount

Taxable Income (after deductions)

 

 

 

Bracket Percent

 

 

 

Bracket

Tax

Bracket Amount Gross Income (without deductions)

 

 

 

Bracket Percent

 

 

 

Bracket

Tax

 

 

 

0

0.00%

0

0

10%

0

10,000

3.00%

0

16,750

15%

1,675

16,750

11.25%

203

68,000

25%

9,363

68,000

18.75%

5,968

137,300

28%

26,688

137,300

21.00%

18,962

209,250

33%

46,834

209,250

24.75%

34,071

373,650

35%

101,086

373,650

26.25%

74,760

 

(Note:  This table shows the effect of a 25% cut, but it is not a predictor of the tax a particular taxpayer would pay under The Clean Slate, because the 2010 brackets are after Tax Expenditures.)

 

In addition to these new rates, income over one million dollars would be taxed at approximately 30%.  All investment income (capital gains, dividends, interest, rents and royalties) would be taxed at the same rate:  approximately 18%.

 

5.            Broadens the Tax Base, Cuts Expenses.

 

The Clean Slate would collect more taxes at far less expense through withholding.  The Clean Slate is a fair and transparent system where expensive tax advisers can no longer develop tax dodges for the wealthy.  The Tax Policy Center estimates that a simple withholding system allows about 5% evasion while a self-reporting system allows up to 50% evasion.  The Clean Slate would move US evasion rates closer to 5% from 15% currently.  The National Taxpayer’s Union estimates that our taxes are 20% higher than they should be because of tax evasion.

 

6.            Fairness.

 

The Clean Slate would be seen to be fair and transparent because the rates would apply to everyone’s income without any deductions or variations.  If you know the income level you know the tax rate.  A recent poll revealed that 85% of the public thinks the present tax code is unfair and too complicated.  The top 400 earners in America paid a 16.6% tax rate according to the IRS.  Non-compliance has been rising as the perception of unfairness has risen. Non‑compliance has reached approximately $450 billion per year which is significantly higher than 10 years ago.

 

7.            Political Advantages of The Clean Slate.

 

Instead of tinkering with some of the tax expenditures and lowering the rates a little bit, The Clean Slate offers a 25% rate reduction and the elimination of the burden of filing tax returns.  The Clean Slate also eliminates the need for aggravating tax record keeping and the threat of audits and dealing with the IRS.  This would eliminate one of the sources of irritation between the public and government.  The Clean Slate can be expected to improve public attitudes toward government. 

 

Tinkering with Tax Expenditures invites each special interest to attack each change. Eliminating all Tax Expenditures allows the debate to shift to overall fairness and simplicity without debating each special interest separately.

 

8.            Questions and Answers About the Operation of The Clean Slate.

 

Q.            What about corporations and proprietorships?

 

            A.            There is no change to their tax system. Proprietorships with more than $5,000 of business revenue would be taxed like all other businesses.  They could be required to file the equivalent of a Form 1040 Schedule C; or alternatively, caused to migrate to an expanded system of withholding through banks or payroll services.

 

Q.            How do companies set withholding rates if payees have several jobs or change jobs?

 

            A.            The IRS now collects payment information from all sources with respect to each person.  The IRS can add them up and notify each company what the withholding rate is for each person based on the total.  Alternatively, employers could check an IRS secure website for that information through an automated database inquiry.

 

Q.            How do companies withhold on capital gains if they don’t have the tax basis?

 

            A.            Many companies, like banks and brokers, already have the basis information, and starting in 2011, must already report basis and holding period to the IRS on certain transactions.  In other cases the company would have to get the information from the taxpayer.  If the taxpayer does not supply it, the full amount is taxed so there is every reason to provide the tax basis to the payor for withholding purposes. Information so provided would be subject to normal tax reporting fraud rules.

 

Q.            Who wins and loses under The Clean Slate?

 

            A.            Fairness, simplicity and clarity are more important to most people than trying to juggle competing special interests.  The present system is so full of winners and losers that the public does not support it anymore.  “Four in every five adults say the federal tax code is complex (85 percent) and say that the tax system needs to be completely overhauled or needs major changes (82 percent),” according to a 2009 poll by Harris Interactive for the Tax Foundation.

 

Q.            What about negative income tax payments?

 

            A.            Presently some low income taxpayers who pay no income taxes receive payments from the IRS when they file a return.  Such payments should be handled by Health and Human Services within a comprehensive program of government assistance based on total need, rather than just a tax return.

 

Q.            But I like the mortgage interest deduction.

 

            A.            The same result can be better achieved by using the current interest deduction tax expenditure dollars to pay that amount directly to mortgage holders to reduce your monthly mortgage payment. This would be more fair to all the taxpayers who now do not itemize.  The mortgage interest deduction has the effect of shifting the tax burden away from itemizers to those who use the standard deduction.

 

Furthermore, a 25% rate reduction is worth far more to anyone than the interest deduction.

 

Q.            And I really like the charitable deduction.

 

            A.            The charitable deduction could be preserved in a withholding system by making it a pre-tax exclusion and directing the company collecting withholdings to send the charitable contribution to one of the donor-directed funds just like they do with retirement contributions.

 

Currently only the minority of taxpayers who itemize get any benefit from the charitable deduction. This would be more fair.

 

With Tom Garton and Jonathan Libbey.

 

 

 

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