The Tax Tussle: If it Ain't Broke...
By Herbert Stein
I believe that all this discussion is seriously mistaken, and possibly intentionally misleading, for two reasons. First, it implies an erroneous notion of the purpose of the tax system, and second, it reflects an exaggerated impression of the costs of compliance.
One can ask whether a pencil is a simpler writing instrument than a word processor. The answer obviously depends upon the purpose for which the instrument is to be used. If the object is to do a crossword puzzle, the pencil is simpler. If the object is to write a long document, revise it along the way, check the spelling, insert charts and footnotes, make a clean copy and store the work in a small space the computer is much the simpler instrument, even though it comes with a thick instruction manual.
Moaning about the complexity of the income tax assumes that the object is simply to raise about $600 billion of annual revenue. If that is the object there surely are simpler systems than the federal income tax. But suppose that the object is to raise that much money in such a way that the higher the taxpayer's income is, the higher the proportion he pays in tax. Most of the radical alternatives to the income tax that are now being proposed gain much of their simplicity by giving up the attempt to do that, or to do it to the degree that it can be done by the present tax system. The difficulty of filing an individual income tax return does not result from the existence of a schedule of five different tax rates. The IRS provides a table that relieves most taxpayers of doing the simple arithmetic involved in that. The difficulty arises from requiring the taxpayer to list all his deductions and sources of income. The deductions problem can be solved by eliminating deductions for taxes paid, for charitable contributions, for medical expenses, for mortgage interest and so on. Minority Leader Richard Gephardt's proposal would do that, except for that most sacred of sacred cows the mortgage interest deduction. The ideal of eliminating the deductions raises howls from the expected sources, but it is a route to simplification, if that is the main objective.
The basic difficulty is the requirement that individuals list all their sources of income not only wages and salaries but also interest, dividends, capital gains, self-employment income, business income, rental income, pension distributions and anything else they have. A sales tax would bypass this problem by making it unnecessary for individual taxpayers to file any returns at all. But that would also eliminate any possibility of progressivity except in a crude and limited form by exempting from the sales tax some kinds of purchases believed to bulk largest in low-income budgets.
Sens. Sam Nunn (D-Ga.) and Pete Domenici (R-N.M.) have a plan that they say preserves progressivity while promoting savings. But their proposal also shows that taxing consumption is no way to achieve simplification. The taxation of consumption at a progressive rate -- i.e, the more the consumption, the higher the rate requires a more complicated return from the taxpayer than the taxation of income does, because it requires a calculation of savings that can be deducted from income to arrive at consumption.
The Armey flat tax achieves a high degree of simplification by not requiring the individual taxpayer to report and pay tax on any income other than wages and salaries. All other income, which is essentially the quarter of the national income that is a return to capital, would be taxed only at the business level and at a flat rate. Thus, a dollar of dividends would be taxed at the same rate whether the dollar accrued to a person with $10,000 of income or to a person with $1 million of income. Gephardt cannot achieve the same degree of simplification because he wants the individual to pay tax on that kind of income at the same rate as on wages and salaries, which requires that he report all that income.
The question before the American people is not whether they would like a simpler tax system. Of course they would. The question is how much of the ability to levy taxes progressively they are willing to give up in order to achieve greater simplicity. Or, to put the question more crassly, how much additional tax are middle-income people willing to pay in order to achieve greater simplicity, for themselves and, especially, for the higher-income taxpayers who have more complex tax returns. So how complicated is compliance with the federal individual income tax? Some people like to frighten us by pointing to a 10-foot shelf of impenetrable language that constitutes the federal tax code. But, in fact, few taxpayers have anything to do with that.
In 1993, 114 million individual income tax returns were filed. Of these 21 million were filed on 1040EZ and 28 million on 1040A, both very simple forms. The basic form, 1040, was filed by 65 million taxpayers, but of these half took the standard deduction rather than itemizing their deductions. These were probably also very simple returns. Almost two-thirds of all the taxpayers filing the basic return 1040 used the assistance of a paid tax-preparer. This fact is sometimes cited as evidence that the tax must be very complicated. But specialization is an aspect of a highly developed economy. We no longer grind our own flour, cut our own hair or repair our own automobiles. There is no more reason to expect that everyone should do his own tax return than that everyone should be his own cardiologist.
Of the 35 million people who file form 1040 and do not take the standard deduction, probably about 10 million do not feel the need for help from a paid tax-preparer. I will give myself as an example. My return for 1994 came to 34 pages of schedules, not because my income is so large but because I have a large variety of income sources, expenses and deductions. I encountered some problems in filling out the forms, but I found the answers in a few paragraph of a book that I bought for under $15 and that is smaller and clearer than the manual for my computer. Then I used a computer program costing around $30 that guided me step-by-step through my entries, called attention to any discrepancies, did all the calculations and printed out the results. When I was through I felt that I had met a challenge and had learned something about my own finances as well as about the income tax.
I may be unusual, but not extremely so. (People think that because I am an economist I have exceptional ability to forecast interest rates and the stock market and to understand the income tax. Unfortunately, that is not so.) Over one-fourth of all households now have computers, and the proportion must be higher in households that have complex tax returns. We are raising a generation of children who have been using computers since kindergarten and who will wonder why we found the income tax difficult. By their time the postcard, of which the flat-taxers are so proud, will be obsolete, as will the post office.
The flat-taxers have come along too late. In another generation, in Newt Gingrich's brave new world of high tech technology, all economic transactions will be electronically recorded in financial institutions, whence they will be electronically transmitted to the IRS computer that will calculate the tax liability of each individual taxpayer and instantly debit his or her bank account. Some people will miss the fun of doing their own income tax, but I suppose they will find other amusement. For the present, compliance with the income tax is burdensome to some. But so are other responsibilities of membership in this society, like jury duty, voting and, if necessary, serving in the armed forces. If, as I think, progressive taxation is a feature of a good society, the compliance costs are not too great.
Herbert Stein is a senior fellow at the American Enterprise Institute. His latest book, written with Murray Foss, is "The New Illustrated Guide to the American Economy" (AEI Press).
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