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Essay: Changing the US tax system

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  • Published: 11 January 2023*
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It has been almost 30 years since Congress has made any changes to our current tax system. Thankfully, as this is being written, a new rejuvenating tax plan is currently being prepared to be sent to the President’s desk to be signed into law. While this is a major step, it is still important to understand where the current system has left Americans, even if it is only the system for a few more days. It’s important not just to understand just because, but so that we do not return to the ways of old, ways which hurt the average American citizen. Although it may only be in place for a few more days, this paper will discuss why certain aspects of the current and potential solutions to this vital issue.

Policy Problem

A Broken System

The current tax system in place, is in a word, damaging to the American economy. Americans are taxed on everything they possibly can be. Their paychecks are taxed, which goes to a myriad of different government debts and welfare programs. To put it bluntly, the current federal tax system is complex, unfair, and confusing to the taxpayer in many ways. The individual income tax also accounts for almost 50 percent of government funding in the United States . Overall it does nothing to promote the individual wealth of the American citizen or growth of the economy.

The main problem with our tax system, first and foremost, lies within the federal government. While this report is not meant to focus on the issues within the government, it is important to understand where the issues stem from. At the end of the 2015 fiscal year the American taxpayer had the burden of more than 18 trillion dollars in government debt . 3.4 trillion of those dollars came from 2015 fiscal year alone . This due to loans, loan guarantees, and more than 150 federal programs . It is also reported by the Federal Reserve Bank in Richmond, that an estimated 61 percent of all liabilities throughout the U.S. financial system are backed by the government . This percentage is also believed to be miscalculated since the governments accounting methods generally underestimate the cost, which of course burdens your average tax payer.

While the preceding information regarding the government and its debt are just a snapshot, it does give you an idea of how reckless spending by the government can affect the individual tax payer. For example, it is due to these issues that Americans see high marginal tax rates. Not only for individuals, but for families, businesses, and investors as well. Citizens in some states are paying tax rates that exceed 50 percent, and that rate only including their federal and state income taxes, not the other taxes they’re paying on top of that . Not only are there high marginal tax rates, but the tax system is unfair to the top wealthiest earners in the country. They should not necessarily pay the same as everyone else, but the percentage of tax owed should be closer than the current system still in place.

The fact that current system also does nothing to promote the wealth of the individual is due to an improper tax base. The current system in place double taxes on savings and investments, therefore discouraging any type of savings. Basically, income that one earns is taxed then once they invest it and go use the money later in life, it is taxed again. This not only effects the individual, in the sense that it discourages them from saving for a rainy day or for their retirement, but the economy as well. It is since the individual is more likely not to save to avoid the double taxation, this stumble economic growth.

Not only are their issues such as high tax rates and the discouragement of investment, but another major issue with the current system is the fact that it is so complex and costly. This complexity leads to an increase in noncompliance or people underreporting on their taxes, underpaying on their taxes, or just not filing all together. Which, essentially could be because they feel as though they may be able to “fly under the radar” due to the complexity of the system. Complexity can also lead to people missing out on money that may be owed to them. If those who are filing their taxes run into issues, they maybe more likely to take the safe route and miss out on money that could be coming to them. This issue may simply be because people want to avoid issues with the IRS (which, is a whole other problem in itself).

Corporate Taxes

The individual tax system while a mess in itself, the corporate tax system is just as bad, if not worse. The United States has the highest corporate tax rate in the world of 35 percent; 38.9 percent when the state average is included as well . When corporate profits are taxed at the business level, they can then be distributed back to the shareholders or held onto for future investments. When the owners of those corporate shares choose to sell and cash out, they are then taxed again on these profits. This system, again, does nothing but add to the complexity the tax system. These high corporate tax rates can also, in the long run, hurt workers and lead to lower wages. In turn, this goes back to affecting the individual.

Amongst hurting the American worker and economy, high corporate tax rates also discourage international businesses from coming and investing within U.S. borders and negatively effects the economy in the long run.

Such taxes, however, do not only take a toll on the big businesses in this country, but they are also very hard on those trying to start up a business as well. These extreme regulation, many businesses unless, they have perfected their business model are likely to fail shortly after beginning. This is because of the way the tax code is structured. It essentially discourages entrepreneurs from taking risks.

Why are these issues so?

Individual

So how do we know that these preceding issues are having a negative effect on both the individual and corporate tax payers? The answers lie within the tax code itself. The understanding of the actual tax code yields much knowledge on the issues with present system.

Before getting into the specific issues the changes in the actual physical properties of the tax code must be discussed to see what it is specifically is being worked with. Since its creation, the tax code has expanded greatly in its size and actual range of capabilities. In 1955, the Internal Revenue Code (tax law) stood at 409,000 words . Today it is 2.4 million words . This though is only the beginning of the complexity problem. The IRS has also released around 7.7 million words of tax regulations that attempt to clarify how the tax statues are put into practice . There are also almost 60,000 pages of tax-related case law meant for accountants and tax-lawyers to figure out how much their clients may owe . This in itself can be proof of a problem. However, there is more.

Due to the complexity of such a system, according to the Office of Information and Regulatory Affairs, in 2016 alone it was projected that Americans would spend more than 8.9 billion hours complying with the IRS tax filing requirements .These compliances and complexities also costing the individual tax payers almost 99 billion dollars . A majority of this cost simply for the fact that many people hire some to do their taxes for them.

Couple this complexity along with the high tax rates that Americans are paying it quite clear as to why the U.S. is in need of tax reform. Under the current tax plan, there are 7 brackets . You have your lowest tax rate at 10 percent, your mid tax rate at 28 percent, and then you have your highest tax rate at 39.6 percent . So, an individual making 418,400+ is taxed 121,505.25 and then they are taxed 39.6 percent anything over that . There are also different brackets for married couples filing jointly.

Corporate

The issue with the current corporate tax rate is that it is the highest in the world at 35 percent. This is damaging to the economy though for many reasons as well as its workers. For starters, higher corporate tax rates equals lower wages. In a report done by the Heritage Foundation, they note that in a study done using aggregate manufacturing wage and tax data for 72 countries from 1981-2002, that a $1 increase in taxes led to a $3-$4 decrease in wages . They also note that the laborer generally bare around 75-100 percent of the tax burden .

The corporate tax system is also discouraging businesses from investing in themselves as well. The tax code actually denies businesses the ability to deduct their investments at the time that they make them. The code instead makes them deduct investment over a period of years and sometimes up to 39 years .  This part of the code alone demonstrates that they system is unfair against investing and raises the cost because of the time value of money. If you have less investment, you have less gains, wage growth, and job creation.

While the tax system is rough on large corporations, it is also harder on those trying to start a business as well. As mentioned as part of the problem, the system works greatly against the entrepreneur. Since it is often that businesses when starting up run a deficit for the first few years the code actually is actually tougher on these start-up businesses and imposes on them a larger tax burden if they take longer to turn a profit. The reason that this is so is because of the lack of equal treatment between business profits and losses. As soon as a business makes a profit, they are subject to taxes. If a business reports a loss, they are not always subject to a break. In fact, businesses are not able to write-off their losses until the turn a profit. For example, should a business run a $1 million-dollar deficit its first year and does not turn a profit until its tenth year, they are not able to deduct that $1 million dollars until the tenth year . So, while businesses are subject to immediate tax upon a profit, they do not really receive and sort of assistance if they are in the negative, thus discouraging business start-ups.

Alternative Policy Options

Individual

In order to reform the current tax system for the individual the current code must be made simpler and more understandable. This is so that people know exactly how much they pay to the federal government. Since there is a current tax bill that is getting ready to be passed into law this report will analyze the changes made to both the individual and business taxes.

The individual changes to the tax plan, it is believed will do much for the common tax payer as well as stimulate the economy. It will do this through a myriad of changes. The main thing that it will do, is lower the individual tax. While the seven brackets will remain, there are higher income thresholds with lower rates. As mentioned early in the report, you had your 10, 28, and 39.6 percent brackets with the threshold for the 39.6 rate set at 418,400. Under the new plan, while you still have your 10 percent rate, the median rate is now 24 percent, and the highest rate is not 37 percent . The threshold now for the 37 percent rate being 500,000+ .  The standard deduction also increases for single payers from $6,350 to $12,000 .

While this current tax plan will most likely put a jolt into the economy, there is still a bit of the complexity that remains. In the original plan outlined by then presidential candidate Donald Trump, he wanted to cut the tax brackets from seven down to a respectable three. This is something that most likely would have leveled the playing field even more so. It also comes close to the idea of implementing a flat tax system or individuals simply paying a standard tax on their labor income.  Again, while the new tax brackets are suitable as they do shrink the gap among tax payers and provide cuts, the three brackets would have done so in a greater way. While, he may have never outright said it, Trump’s original plan was to be able to have Americans fill out their taxes on a post card. This is something that would have been great.

Again, the issue here is not this tax bill will not help the economy and is not a vast improvement upon what was already in place, it’s just that there could have been more done to help the taxpayer. However, this type of thinking maybe, for a lack of a better term, greedy. Greedy in the sense that it must be realized that the federal government has dug its heels in some tight in regard to taxes, that asking for too much up front may have caused the system to bite back in a sense. Even the current tax bill did not receive any Democratic support.

Another tax aspect that should change, is in the savings and retirement area. In fact, something along the lines of the British Individual Savings Accounts (ISA). With an ISA individuals are able to contribute after-tax earnings, but then pay no additional taxes on interest, dividends, or capital gains on earnings. Those saving can also withdraw funds at any time without any sort of penalty . This system, of course, in vast contrast to the U.S. system since due to the tax base, Americans are taxed double on their investments. The income that is invested or saved is taxed, and then taxed again it withdrawal.

Corporate

Also, included in the current tax plan were major cuts to corporate taxes as well. These changes will not only boost the economy, but they will also make the U.S. more attractive to international businesses bringing more jobs to America. The biggest change comes in the form of the actual corporate tax rate itself. What was 35 percent will be reduced to 21 percent starting in 2018 . While state taxes will also be included in this driving the rate up to just around 26 percent, a little above the worldwide average of 23 percent, this is still a start . This new competitive rate will make still encourage investment in the U.S. resulting in higher wages and more jobs for many.

While again, this is a good start, there still must be more improvements made to the current system to continue to help business. To also further simplify the code, implementing an idea such as a traditional flat tax would something that would also assist businesses greatly. With the flat tax, businesses would take their gross income from their sales or goods or services and then subtract from that amount the cost of buying whatever it is they need in order to run their business effectively, including labor costs. The business is then taxed a flat rate on their remainder. This would make it clear cut and simple for the business. Along with this idea though, there must also be an additional reduction in the tax rate. Potentially around 18-19 percent. It would be this simplicity of the tax code along with the lowering of the tax rate a few more percentage points, that would really put the U.S. on top in regard to worldwide corporate competition.

Criteria

Simply put, these options outlined above for both the individual and the corporate tax policies would only continue making the American dream that much more of a reality for those here and those who want to come here. If we take a look at some of the numbers that are being projected for the current tax plan for the economy, one can only surmise that additional reduction in tax rates and regulation, would lead to additional economic growth.

We can also take a look at Ronald Regan’s Tax Reform Act of 1986 . This act was one of the greatest in economic history. Regan was able to close certain tax loopholes and lower tax rates, which he knew would create gains. This act also reduced the number of tax brackets down to two resulting in one of the biggest rate reductions in American history and also closely resembling a sort of flat-tax system . Trump, much like Regan, understands that high tax rates discourage work and investment and hurt the economy. Under Trumps plan it is projected that the long-run GDP will grow by 1.7 percent resulting in higher wages and capital stock, as well as increasing the number of jobs available . This is why it is believed that should Trump’s initial plan for only three tax brackets had made it into this plan, it would have been an even greater economy stimulator.

The main criteria should be to simply, not only reduce tax rates for the individual and the corporate, but to simplify the code as much as possible. Make it understandable for your average citizen  so that they do not need to rely on the government, or on others to tell them what they need to do in order to meet all of the regulations that are in place.

Conclusion

When tax rates are cut and the code is simplified there can only be one real projected outcome in this situation. It will revitalize not only the economy, but the American peoples as well. People want more money I their pockets to do what they please with it, as it should be. Corporations are also more likely to be more generous towards their employees. In fact, it has been reported by multiple outlets, that companies like AT&T, Boeing, and Wells Fargo are giving their employees more money, like raising their minimum wages or giving bonuses .  Boeing is also going to invest more money in their training programs for their employees . This will result in happier employees which, and it is this attitude that will be passed along to the consumer.

To help understand what cutting taxes would like we can, again, reference Regan’s major tax cuts. By the end of the 1980’s Regan’s tax cuts had boosted tax revenue from $500 to $1trillion . Economist Larry Lindsey also found that tax cuts for the highest incomes even paid for themselves since the cuts encouraged work and investing . What this says, is that lowering taxes works. The same will be for the current tax cuts as well. In fact, the tax plan that was just signed into law by President Trump, is projected to raise the GDP by 2.2 percent . This roughly translates to around an additional $3,000 per family, give or take .

The only issue, again, with these cuts is that they were not a little bit bigger. The main reason one can surmise as to why President Trump’s idea for the original three brackets did not make it into law is because there is most likely no way that would have been passed. Congress will need to revisit the code over the new few years and make certain changes and revisions to it to make it that much better.

As David Burton of the Heritage Foundation put it “The sheer complexity of the system makes it difficult to understand the true impact of the tax system,” this should not be so . While the current Tax Cuts and Jobs Act is a start, President Trump and Congress need to make additional efforts over the coming years to continue to simplify the tax code. Because again, even though, this is an improvement, there is still more that can be done. The code needs to be cut down and simplified, rates need to be cut more, especially for corporate America. These types of things will work, they will rejuvenate the people and in turn the economy.

Originally published 15.10.2019

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