Personal Tax Review - US Tax Reform

By Editorial, 31 July, 2013

President Obama, when on the campaign trail in 2008, envisaged a dramatically simplified tax system whereby 40 million Americans would be able to complete their tax returns in less than five minutes without the paid help of an accountant. Clearly, this utopian vision of the US tax landscape has failed to come to pass, but as Congress begins to debate comprehensive tax reform in earnest, personal taxpayers struggling to comply with America’s dysfunctional tax system at least have some cause for optimism.

Besides cutting taxes for the middle classes, the following was pledged in Barack Obama’s 2008 Comprehensive Tax Plan: “Obama will reform our tax system to greatly reduce its complexity, consolidating several credits and giving taxpayers the option of pre-filled tax forms to verify, sign and return. Under the Obama tax plan, 40 million Americans who take the standard deduction will be able to do their taxes in less than five minutes and will not have to hire an accountant. This will save Americans more than USD2 billion in tax preparer fees and more than 200 million hours of work.”

The reality, as highlighted last January by National Taxpayer Advocate Nina E. Olson in her 2012 Annual Report to the United States Congress, is quite different: “The existing tax code makes compliance difficult, requiring taxpayers to devote excessive time to preparing and filing their returns. ... It obscures comprehension, leaving many taxpayers unaware how their taxes are computed and what rate of tax they pay.”

Olson added: “It also facilitates tax avoidance by enabling sophisticated taxpayers to reduce their tax liabilities and provides criminals with opportunities to commit tax fraud and it undermines trust in the system by creating an impression that many taxpayers are not compliant, thereby reducing the incentives that honest taxpayers feel to comply.”

The report states that the tax code imposes a “significant, even unconscionable, burden on taxpayers.” Since 2001, Congress has made nearly 5,000 changes to the tax code, an average of more than one a day, and the number of words in the code appears to have reached nearly four million, Olson observed.

In particular, Olson pointed out that it takes US taxpayers (both individuals and businesses) more than 6.1bn hours to complete tax filings; it was estimated that it cost individual and corporate taxpayers USD168bn to comply with the tax code in 2010; and around nine out of ten Americans rely on paid professionals or commercial software to prepare their tax returns (nearly 60% of taxpayers hire paid preparers; another 30% use software).

Olson considers that: “If tax compliance were an industry, it would be one of the largest in the US.”

Or, to put in another way using an oft-repeated phrase of chief House of Representatives tax writer Dave Camp (R - Michigan), the tax code “is ten times the size of the Bible with none of the Good News.”

Not that we are ascribing blame for this situation to President Obama. Congress has played its part by passing temporary fixes to the tax system which repeatedly kick the more fundamental issues about how Washington taxes and spends down the road for another day. The last-minute deal to avert the fiscal cliff last January was a prime example. Furthermore, the tax code was broken way before Obama arrived in the White House; the current state of affairs is the culmination of almost 30 years of Congress adding various special interest tax provisions to the code – “pork” in the language of D.C. – since the last major reform took place in 1986. Besides, all presidential candidates propose tax reform plans that range from the merely difficult-to-do up to utterly outlandish (see Herman Cain’s “9-9-9” plan), and Obama’s plan was probably at the more conservative end of the range. Nevertheless, Obama certainly hasn’t helped improve things. Indeed, the various temporary tax credits and other time-limited tax breaks passed since 2009, and his heavy emphasis on tax compliance, have tended to make a bad situation worse.

However, while many Americans have burned the midnight oil attempting to comply with their tax obligations, a lot of work has been taking place quietly behind the scenes in Congressional committees to prepare the way for the first clean sweep of the US tax code since President Reagan sat in the Oval Office. The Senate Finance Committee, which has jurisdiction over tax legislation, has conducted 30 hearings on a range tax reform options over the past couple of years, while over in the House, its equivalent, the Ways and Means Committee, has held 20 on mostly the same issues. Earlier this summer, the respective Chairmen of these committees, Max Baucus (D – Montana) and Dave Camp, combined their efforts and took to the road to sell the idea of tax reform in a number of US cities.

Said Baucus in a recent statement designed to elevate the importance of tax reform in the consciousness of his fellow Senators: “Our tax code today is inequitable, inefficient and incomprehensible to the overwhelming majority of Americans. It contains nearly four million words — four million.  If someone were to try and read the entire code aloud, it would take them more than 18 uninterrupted days. Not only is the code long, but it is maddeningly complex.  There are 42 different definitions of a small business in the code — 42. There are 15 different tax incentives for higher education.  So many that the IRS had to publish a booklet just to explain and simplify the higher education tax incentives.  And that book is 90 pages long.

“The tax code today is also inefficient and unfair,” he continued. “It is riddled with loopholes and deductions that result in more than USD1 trillion in lost revenue each year.  This complexity in the code is eroding confidence in our economy and creating uncertainty for America’s families and businesses.  It is also threatening to undermine the competitiveness of the United States in the global marketplace.”

In announcing a hearing into how the tax code burdens individuals and families on April 6, 2011, Camp echoed Baucus’s sentiments. “As the deadline for filing individual tax returns approaches, the time for simplifying and stabilizing the tax code for individuals and families is also upon us,” he observed. “With so many Americans struggling to meet their tax compliance responsibilities, Congress and the President need to work together to achieve a tax system that is fair, simple, and efficient.  While some seem to prefer a ‘business-only’ approach to tax reform, we owe it to the hard-working taxpayers we represent to ensure that they are not left out of this discussion.  This hearing will help the Committee better understand the many problems that plague our tax system as it affects individuals and families across the country.”

In addition to the 20 separate tax reform hearings since January 2011, the Ways and Means Committee has released a series of discussion drafts, covering mainly business topics, and created 11 tax reform working groups in February 2013, each led by one Republican Member serving as Chair and one Democratic Member serving as Vice Chair. These working groups covered the following areas of taxation: charitable/exempt organizations; debt, equity and capital; education and family benefits; energy; financial services; income and tax distribution; international; manufacturing; pensions/retirement; real estate; and small business/passthroughs.

Meanwhile, the Senate Finance Committee has also been busy advancing the cause of tax reform this year, having released a series of 10 tax reform options papers. These papers include: Simplifying the Tax System for Families and Businesses; Business Investment and Innovation; Family, Education and Opportunities; Infrastructure, Energy and Natural Resources; International Competitiveness; Economic and Community Development; Economic Security; Types of Income and Business Entities; Tax-Exempt Organizations and Charitable Giving; Non-Income Tax Issues and Related Reforms.

An examination of all these hearings, as well as the numerous discussion and tax reform option papers issued by both Congressional tax writing committees would fill up many volumes. Therefore, issues discussed and options proposed in three of the Senate Tax Reform Option Papers affecting mainly individual taxpayers are outlined below:

Senate Tax Reform Option Papers

Simplifying the Tax System for Families and Businesses Paper

Presented on March 21, 2013, this paper dealt with the administrative and compliance burdens placed on both the taxpayer and the IRS. The paper set out broad principles for reform in this area, including:

Options put forward for achieving these aims included the following:

Further proposals were made in the area of collection and enforcement including, among other ideas:

Families, Education and Opportunities

This paper, presented on April 18, 2013, examines those areas of the tax code that have been deliberately put in place to influence individual behaviour, chiefly those that affect decisions about whether to work, marry, have children, and pursue an education. 

The paper lists the following potential broad principles for reform in this area:

Some specific concerns stated in the paper about this complex area of the US taxation system include the following:

The options suggested in the paper to simply this area of taxation including the following:

Types of Income and Business Entity

This paper, released on June 6, 2013, examines the patchwork of inconsistent rules regarding the taxation of income, investments, and tax structures. It considers how the tax code could be made more neutral by reducing or eliminating differences in overall tax burdens across different types of entities, owners, and income, and reducing or eliminate differences in the tax treatment of debt and equity.

The paper lists some specific concerns about the taxation of income and business entities as follows:

Reform options put forward in the paper that could greatly affect individual income taxation include the following:

Where are We Now in the Tax Reform Process?

Earlier this year, John Boehner (R – Ohio), the Speaker of the Republican-led House of Representatives, announced that he had symbolically set aside the bill H.R.1 for comprehensive tax reform legislation, while Baucus has been talking up the chances of a tax reform bill being introduced into Congress by the end of this year. So it is not out of the question that we could see such a bill in the flesh, so to speak, within the next few months. However, despite Baucus and Camp demonstrating that Democrats and Republicans can work well together on certain issues, important divisions remain that could ultimately block a reform bill’s path. The most important one in this regard is whether new revenue should be generated by tax reform legislation, predominately from the rich and large corporations, to pay down the deficit (the Democrat position), or tax reform should be revenue-neutral – in other words money saved by axing tax expenditures should be used to cut tax rates (the Republican position). This ‘elephant in the room’ has not been discussed in the various committee papers and hearings, because the process of preparing the way for tax reform would have stalled very early on if it had. Hence, the following rider was appended to the introduction of each of the Senate Finance Committee’s Options Papers: “Members of the Committee have different views about how much revenue the tax system should raise and how tax burdens should be distributed.  In particular, Committee members differ on the question of whether any revenues raised by tax reform should be used to lower tax rates, reduce deficits, or some combination of the two.  In an effort to facilitate discussion, this document sets this question aside.”

All the work achieved so far suggests that the will is there within Congress for tax reform. But the political reality might prevent it from happening, at least in the current Congressional period, which runs until January 2015.

Tags: compliance | business | interest | payroll | Other | Finance | individuals | investment | United States | penalties | legislation | law | services | education | fees | tax compliance | tax | tax incentives | tax reform | tax rates | individual income tax |


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