If you watch the budget battles in Washington, it might appear the only discussion about taxes is whether they should be increased, cut, or kept where they are. But policy experts are engaged in a tax conversation that may be more important—how to make the tax system simpler and smarter.
Currently, terms to describe the current code are more like “complicated,” “obscure,” and even “unconscionable,” all of which have appeared in reports by tax policy groups looking at how to fix the system. The cost of navigating this maze to taxpayers and businesses hit $163 billion in 2010, more than 1 percent of GDP. It’s gotten so bad that small and mid-sized companies have started passing up tax breaks they’re eligible for because they’re too confusing and costly to take, according to a report last summer in the Wall Street Journal.
RELATED: 13 Tax Breaks You’ve Never Heard Of
Despite the agreement on the need to clean up the tax system, almost every tax law has a constituency that will fight hard to keep it. Intuit, the maker of TurboTax, has spent some $11.5 million lobbying to keep the tax filing process complicated for taxpayers, according to a recent report by ProPublica and NPR.
To measure the effectiveness of each tax law, experts have devised several criteria. The U.S. Government Accountability Office, for example, has three measures: (1) a tax law’s fairness, (2) the extent to which it promotes economic efficiency (that is, provides more economic benefits to society than the private sector would provide on its own), and (3) the degree to which it’s simple, transparent, and easy to administer by the IRS.
Here are ten tax laws that could stand to be revised—or eliminated all together:
1. The AMT boondoggle: Congress passed the AMT in 1982 to ensure that the well-off pay at least some tax each year. But a report earlier this year from the National Taxpayer Advocate, the watchdog arm of the IRS, says that the AMT doesn’t achieve that goal at all--many middle- and upper-middle-class taxpayers pay the AMT, while most wealthy taxpayers don’t. And thousands of millionaires pay no income tax at all. Meanwhile, the AMT makes calculating what you owe the government far more complex than it used to be since taxpayers essentially have to compute their tax liabilities twice—once under the regular tax rules and again under the AMT, says the report. Congress at least permanently indexed the AMT for inflation in passing the fiscal cliff deal on January 3. But that doesn’t make it a better tax—it just limits the number of those in the middle class whom the AMT hits.
2. The pro sports subsidy: Current tax law allows the National Football League, Professional Golfers’ Association, and National Hockey League to operate as nonprofits. You read right—the NFL, which generated $184 million from its teams and held more than $1 billion in assets in 2010, pays no federal income tax. According to Waste Book 2012, an annual report by Republican Senator Tom Coburn of Oklahoma, the NFL gets its tax-free status under a provision of the code that allows industry and trade groups like the U.S. Chamber of Commerce to qualify. Cost to the taxpayers? At least $91 million a year just for the NFL and NHL, according to the Waste Book.
3. Byzantine tax phase-outs: If our tax returns are needlessly complicated, one reason is the use of phase-outs, says the nonpartisan Urban-Brookings Tax Policy Center. These are tax exemptions and credits that get limited as a taxpayer’s income rises, with the goal of providing more help to people at lower incomes. But they make figuring out what effect an extra dollar of income will have on the taxes you owe almost impossible. The center notes, for example, that the tax code reduces the $1,000-per-child tax credit by 5 percent of adjusted gross income over $75,000 for single parents. The share of expenses allowed for the child care credit falls from 35 percent to 20 percent as adjusted gross increases from $15,000 to $43,000. And single taxpayers with an adjusted gross above $55,000 may not deduct the interest they pay on student loans. For a more progressive tax structure, the National Taxpayer Advocate recommends further adjusting the marginal tax rates—and killing the phase-outs.
4. The high-tech loophole: The Government Accountability Office notes that there’s a legitimate place for governments to subsidize research that benefits society but doesn’t turn a profit. But there’s no reason for companies to get a subsidy for research and development that they would have done anyway, says the GAO. That’s exactly what happens now—companies like Microsoft, Boeing, and Harley Davidson have taken the research and development tax credit and written off the cost of designing profitable new technologies, products, and processes, notes tax watchdog Taxpayers for Common Sense.http://doeren.com/blog/tag/research-and-development-tax-credits/
5. The convoluted capital gains tax: The Tax Policy Center notes capital gains income is subject to at least eight different effective tax rates, depending on the taxpayer’s regular tax rate, how long an asset was owned, the type of asset, and whether the taxpayer owes AMT— one of the three IRS worksheets used to calculate the tax runs to 37 lines. It’s gotten even more complex in 2013 with a new 3.8 percent Medicare surtax rate starting on those with an adjusted gross income of $200,000 single or $250,000 married. The center favors cutting the thicket of paperwork by allowing a percentage exclusion of capital gains income for long-term gains (to encourage savings) and applying regular tax rates to the rest.
6. Special treatment for Hollywood: At a time when movie studios Time Warner and News Corp. both recorded 2012 profits of about $1.2 billion, it might seem odd that they need a special favor in the tax code. But they got one anyway—as part of the fiscal cliff deal, Congress and the White House renewed special expensing rules for film and TV production. Under that provision, filmmakers and TV studios have the option of immediately deducting (as opposed to writing off over the normal 15 to 39 years) up to $15 million in program production costs as long as 75 percent of the costs are for services performed in the U.S. That may have started out as an effort to keep film and television production at home, but now it amounts to a tax subsidy to Hollywood worth $225 million a year, according to Taxpayers for Common Sense.
7. Tangled education savings subsidies: At least 11 separate incentives in the code encourage taxpayers to save for higher education, according to the National Taxpayer Advocate’s report. All have different eligibility requirements, definitions of terms, income thresholds, and other features. In Congressional testimony last summer, the GAO noted that in 2008 (the latest year data were available) some taxpayers didn’t take the higher education deductions they were eligible for because of their complexity. The Taxpayer Advocate report recommends consolidating the incentives and harmonizing definitions to make it easier for taxpayers to determine eligibility and calculate benefits.
8. The home price inflation incentive: The mortgage interest deduction allows homeowners to deduct interest on up to $1.1 million in mortgage debt. Though the deduction’s rationale is encouraging homeownership, in a report last fall, the GAO noted that it’s more likely prospective buyers are figuring the deduction into the prices they’re already willing to pay for homes, pushing their costs up artificially, says the agency. Many economists and the Simpson Bowles Commission have proposed at least modifying the interest deduction so that it benefits middle- to lower-income taxpayers, who are those most likely to actually need help buying a home. The Congressional Budget Office, for example, has proposed a number of options, including converting the deduction to a tax credit and lowering the current $1.1 million cap to $500,000.
9. Overlapping retirement savings tax incentives: Sixteen separate incentives are jammed into the code to encourage taxpayers to save for retirement, notes the National Taxpayer Advocate’s report. All have different rules about eligibility, contribution limits, the taxation of contributions and distributions, and so forth. So for example, a single taxpayer earning under $28,750 can get both a tax deduction and a tax credit for an IRA contribution—the regular IRA deduction, plus a tax credit called the Saver’s Credit, worth up to $1,000. But a 2012 survey found that less than 20 percent of people had heard of the Saver’s Credit—little wonder with so many choices to keep track of. The Tax Policy Center recommends combining the existing options into fewer alternatives—that would make workers’ choices easier and cut the cost of administering so many duplicative rules, the center says.
10. Gimmicky tax sunsets: Congress increasingly passes tax subsidies that are time limited to make their long-term costs to the government look artificially lower, says the National Taxpayer Advocate’s report—the number of these sunsetting subsidies grew from about 21 in 1992 to more than a hundred at the end of 2011. But they make it hard for taxpayers and businesses to plan since its often unclear whether Congress will extend them. Dozens were set to expire before the fiscal cliff deal at the end of 2012, like the numerous energy-related incentives and a deduction for school expenses teachers pay out of pocket.