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MAC Attack on Taxes

August 20th, 2012 · 2 Comments · Business Management

It would be simple to make taxes simple, but those with the power to do so simply don’t want to do it

It is hard to find anyone from either political party or any political persuasion – except for maybe tax lawyers and accountants – who is willing to publicly defend the current voluminous and complicated tax code. The unfairness, inconsistencies, abusive loopholes and convoluted language of the tax code have been spelled out ad infinitum by the media, academics, politicians and anyone who has ever filled out a tax return.

Now the highly-respected and bipartisan Multi-state Accounting Commission (MAC) has just completed and released a detailed analysis of the US tax code that offered some interesting insight and proposals to simplify the system and make it more equitable.

After an exhaustive four year study, MAC came to a surprisingly simple, yet obvious, conclusion that the real problem plaguing the current beleaguered system is that taxes are calculated on the basis of “taxable income,” as opposed to “gross income.” This means that if an individual with income of $1 million can find ways to exclude all or a portion of that income from the definition of “taxable income,” then taxes are reduced. For example, if $250,000 of the million was the result of “capital gains,” then that portion is taxed at 15 percent, as compared to the standard taxable income rate of 35 percent. This reduces the “effective rate” of taxes paid by the millionaire. Of course, the same options apply to those who are not so wealthy. If an individual earns $75,000 in salary, but pays $4,500 interest on a home mortgage, that amount is deducted from the gross income, resulting in reduced taxes.

A Foot in the Tax Door

In 1913, the passage of the 16th Amendment to the Constitution established the imposition of income taxes as a power granted to the Federal government and (foolishly) put Congress in charge of determining the rules and regulations for the taxes. This idea that the tax rate applied was to be based on “taxable income” as opposed to “gross income,” opened a Congressional Pandora’s Box of potential “exclusions” designed to reduce an individual’s taxable income.

You can see what’s coming here: A Congress that, by its nature, is susceptible to the influence of high-powered lobbying, special interests and the power of money, has, over time, added layer upon layer of exclusions and exceptions to the tax code; all designed to allow those who benefit from the exclusions to reduce their taxable income. (For full effect, pretend like you are surprised Congress would do this.)

(Click on graph to view the tax code overkill)

When the tax code was passed in 1913, it contained a total of 400 pages; the same code in 2012 had grown to exceed 72,000 pages. (There is an unsubstantiated rumor that Paul Ryan has actually memorized each and every one of the pages in the code.) The voluminous pages are not needed to define the tax schedule, but to allow special interests to exclude certain amounts of income (often the majority of it) from the taxable income calculation. This leads to a company like General Electric making $14 billion dollars of profit in 2010 and paying zero in federal taxes and for people like Mitt Romney to have income of over $20 million and pay a tax rate of about 13 percent. (At least that is what he tells us, but was unwilling to show us.) The Huffington Post recently reported that in 2010 at least 26 corporations – including Citigroup and AT&T – paid more to their CEOs than they did in federal taxes.

The New Gold Rush is Here!

The tax code has become a candy machine dispersing all types of goodies and benefits for the rich, powerful, corporations, special interests and last, but certainly not least, for members of Congress, who control who gets the goodies, it is a gushing fountain of funds for re-election and “other things.”

The average citizen can complain all they want about the unfairness and complicated structure of the tax system, but this misses the point. The objective is to make (and keep) the tax system as complicated and byzantine as possible, because that is what is needed and intended to hide the highly lucrative game being played. Simple means transparency and the last thing politicians, most of the wealthy and special interests want is transparency.

MAC says “Let’s Try Something New”

One of the most popular and often recommended options to replace the current tax code is a “flat-tax.” The idea of a flat-tax is that virtually all exemptions are eliminated and everyone pays the same tax percentage, regardless of income. The flat-tax has bounced around the fringes of the political discussion for decades and it has been proposed and also opposed by both Republicans and Democrats. During this year’s Republican Primary contests, Rick Perry, Herman (nine-nine-nine) Cain and Newt Gingrich all expressed support for a flat-tax. In the past, Democratic Senator Bill Bradley and Democratic presidential hopeful Jerry Brown (current governor of California) proposed adoption of some form of a flat-tax.

MAC spent a good deal of time exploring the structure and workings of the flat-tax concept. One thing for sure is that the flat-tax passed the MAC simplicity test. MAC determined that taxes could literally be completed on a postcard and that 98.4 percent of all taxpayers could figure out and complete the form in less than 15 minutes. (It was not 100 percent, because during focus-group tests MAC determined that bankers would probably need help completing the form.) However, in the process of conducting extensive computer modeling and testing, MAC discovered that in a number of scenarios the flat-tax can often result in a regressive tax system. That means that even though the tax rate is flat, those with lower income will end up with higher tax bills than with the current system. The reason for this is that the current tax rates for lower income individuals are lower than what they would likely be if a flat-tax is used.

When it was all said and done, the recommendation made by MAC was very simple. If adopted, it would increase total revenues for the government (when compared to the current system), forms would be easy to complete and the taxes due easy to calculate. In fact, adoption of the MAC solution would reduce tax rates of the very wealthy from 35 percent to 23 percent.

Here is what MAC recommends:

  • Make a simple change in the tax code to base taxes on “total income,” instead of “taxable income.”
  • Total income would include salary, bonus, dividends, investment income, capital gains and all foreign income. (No more hiding income and investments in off-shore tax havens.)
  • Total income also would include “soft income,” such as the value of health care benefits provided by an employer, personal use of the corporate jet and other “fringe benefits” not now included in taxable income.
  • The only “deductions” from total income would be for taxes paid. As such, all local, state and foreign taxes, i.e. city and state income taxes, sales taxes and property tax, would be excluded. Social Security and Medicare taxes would also be excluded.
  • The first $50,000 of income would be excluded and rates above that would increase in stages from a low of 5 percent to 23 percent for income over $1 million.
  • Corporate tax rates would exclude the first $100,000 of earnings and range from 5 to 20 percent. The rates would be based on earnings before interest, taxes, depreciation and amortization. Capital expenditures designed to grow the business, i.e. buy equipment, expand or build factories, in the U.S. would be excluded from taxable earnings.

MAC also recommended three additional actions to stabilize the tax system:

  • The federal budget should be changed from a one year to three year cycle.
  • A requirement that each budget be balanced based on control of expenditures and revenue alone. No tricks, games or deficit financing.
  • Implement a 5 percent national sales tax. Revenue from the sales tax could only be used to reduce the national debt, fund education or infrastructure repair or construction. Those earning less than $75,000 would receive a tax-credit for sales tax paid.

And the Moral of the Story …

The bipartisan analysis prepared by MAC demonstrates that 90 percent of the problems, inconsistencies, confusion and complicated nature of the tax code could easily be resolved by taking one action: Change the calculation of taxes based on easily determined “total income,” rather than the artificial, corruption susceptible “taxable income.” In one fell swoop this would make the calculation of taxes transparent, easy, and above all, understandable.

MAC did acknowledge that under the proposed system, the very wealthy would pay more in taxes than they do now, but that is only because the current system allows the wealthy to pay significantly less (as a percentage of income) than do the middle-class and the poor. The point is that under the MAC proposal the tax system will not only be simpler, but also much more equitable; and even with lower tax rates for all, revenue collected will be higher.

Of course, this is all wishful thinking. As with other proposed tax reforms, the chances of real change being implemented are about as likely as politicians swearing off the use of negative ads in campaigns. The truth is that the tax code is complicated, abusive and inequitable because Congress, special interests, corporations and the wealthy benefit from the current structure, and what to keep it that way.

We have all seen the sci-fi movies where the invading aliens have this powerful “force-shield” that protects them from attack. In the movies the aliens are defeated when a hero figures out a way to pierce the force-shield. But this is real life and while we may know how to pierce the force-shield that is the tax system, no hero seems willing to step up and as a result, the aliens will continue to win. And we will continue to complain, but still be at their mercy. Capt. Kirk, where are you when we need you?

 

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