When Congress returns from its Fourth of July celebrations, it will have to face this: a challenge from the Senate Finance Committee to begin doing something--at last--about the atrociously complex and unfair income tax code, and a long line of lobbyists and tax lawyers eager to explain why each of the things that the Finance Committee proposes to do would spell disaster for the economy and the American way of life.
Armed with facts, figures and pre-drafted legislative amendments, these lobbyists have pretty much had their way with the tax code for years. It is easy during the arcane debate and chaotic proceedings of a tax bill markup to slip another preference into the code. Once there, it's even easier to make sure that the preference stays in place--if only because it's hard for anyone else to know what the provision really means. If you doubt that, curl up with a copy of the tax code for an hour or two.
All of this has done much to fatten the pocketbooks of tax lawyers, lobbyists and their clients. But these benefits have come at a very high cost to the economy. Tax dispensations given to one set of taxpayers mean higher taxes for everyone else. As loopholes have increased, marginal tax rates have risen, which is bad for incentives for work and for saving.
Tax preferences also distort investment decisions. In a rapidly changing economy, business activities that seem to be worth encouraging one year are likely to be inefficient investments a few years later. Since it has been almost impossible to get rid of an outmoded preference, this situation was usually handled by creating yet another tax break to counteract the effect of the first. Thus the tax code grows by virtue of its own inadequacies.
The tax code has become so complex that some loopholes have been created by simple inadvertence. For example, part of the insurance industry is currently gasping over the Finance Committee's proposal to eliminate a $2.3 tax break for the industry that lay undiscovered within the tax code for almost 20 years. Since insurance companies discovered it in 1978, some of them have been able to wipe out their tax liabilities altogether and a preference that no one ever lobbied for or intended has become a cherished fixture of the industry.
Tax preferences now cost the Treasury about a quarter of a trillion dollars a year--more than is spent on defense or Social Security. If all of the preferences in the individual income tax were eliminated--except a single deduction to ensure that no one in poverty paid taxes--a flat tax on income of less than 20 percent would raise the same amount of tax as the current schedule. A few points higher would even finance a modest negative income tax to help the working poor. Tax returns could be condensed to the size of a card and most taxpayers would save money.
The big stumbling block in the way of individual tax simplification is, of course, that not everyone would save money. But even the big users of tax preferences might want to give the matter a little more thought before they line up behind the Capitol Hill lobbyists. Face it--and here I address myself to the growing number of people who have taken up tax dodging as a hobby in recent years--most tax shelters really aren't good investments.
True, you may avoid the distasteful necessity of sending money to the Treasury. But did you really enjoy giving that money to the guy who promised you'd make a killing in bait-worm inventories? Or the fellow who got you in on that commodity pool that turned out to be a Ponzi scheme? If the investment really is a dog-- something that no one would buy into if it weren't subsidized by the tax code--you're likely to lose more than the taxes you would otherwise have paid. That's especially true now that the maximum tax rate is 50 percent.
The idea of replacing the current income tax with a broad-based low tax on income is decades-old. Until this last year, however, it was simply an elegant construct admired by academicians and a few dogged reformers. When I wrote a column about it just a year ago, the tax system seemed headed in quite the opposite direction. Indeed, last summer's tax bill set new records for tax favoritism and complexity. Since then, the idea of tax simplification has suddenly taken off, endorsed in one form or another by politicians of the left and right.
Perhaps that's because the tax code has finally reached some tipping point--the stage at which the enormous differences in the tax burdens paid by people with the same income, the mind-boggling complexity of the tax forms and the increasing opportunities for tax evasion have produced a popular revulsion sufficient to give Congress the needed courage for tax reform.
Last year when I wrote about the virtues of tax simplification, I received a surprising number of supportive letters from people all over the country. Many asked what they could do to push the idea along. Write your congressman, I told them, and tell him that there are more people interested in the tax code than the lobbyists who visit him every day. Now--while the Senate Finance Committee is waging its still lonely battle for a start at tax reform--is an even better time to do it.