Arnold Kling  

Tax Simplification

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Bruce Bartlett writes that we have met the enemy and he is us.


If people really want simplicity, it can be done. But my experience is that when push comes to shove, people would rather have complexity and keep whatever tax provisions benefit them. In the end, the demand for true simplicity always ends up being a mile wide and an inch deep.

I think that the problem is that K street lobbyists are an inch wide and a mile deep. They are the beneficiaries of the complexity of the tax code. Although Bartlett may be correct that there is no groundswell in favor of tax simplification, I think that the constituencies for tax loopholes are not as strong as K Street represents them to be. My guess is that most Congressmen could vote to kill the so-called sacred cow loopholes without being voted out of office.

For Discussion. Would it be feasible to phase out the mortgage interest deduction, or would that be politically impossible?


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CATEGORIES: Tax Reform



COMMENTS (38 to date)
Lawrance George Lux writes:

'Sacred Cow' deductions are basically such because Lobbyists pay Media to claim them as such. Lobbyists are not 'an inch wide and a mile deep', they are 'an inch wide with a budget of several Millions of dollars'. lgl

Andrew writes:

In the UK, tax relief on mortgage interest was phased out from 1994 to 2000.

http://www.guardian.co.uk/budget99/Story/0,2763,209378,00.html

Steve writes:

I heard on the radio that there were riots in the streets when the UK government suggested that students might actually have to pay for university.

Joseph Kristan writes:

In the short run, it's not possible. While the comments above note that it was done in the U.K., that was only possible because of the party discipline in their system.

Long-term, it only is likely in the context of a major tax reform - perhaps if a large exemption amount replaces all itemized deductions.

Andrew writes:

Steve -- indeed, free university education, rather than home-ownership subsidy, is the core "middle-class perk" that will be politically difficult to eliminate (though there have not been any riots yet). Mortage interest tax relief went relatively quietly. Significantly, the process was started by one party and completed by the other, while university tuition fees are being opposed by the Conservative party.

http://news.bbc.co.uk/1/hi/uk_politics/3355165.stm

Background:

http://news.bbc.co.uk/1/hi/education/3013272.stm

Steve writes:

Removing home ownership subsidies in the US would take down the housing market, and likely the entire economy. I'd like to see some evidence to the contrary. Did the UK have anywhere near as high of home ownership as the US?

Steve writes:

Ok, here's a proposal that will pass:

Drop the housing subsidy, but raise the standard deduction by $20,000. It will save the dwindling middle class (at least for a few years before their jobs are exported), and the GOP will rid the country of that pesky "small/mid-sized home ownership" thing.

Andrew writes:

Steve -- The UK has quite a high level of home ownership; the Guardian article I linked says 10 million borrowers were receiving relief, which I would guess is in the region of 40-50% of households. (UK population ~ 50 million).

A key difference is that UK mortages are normally variable-rate: as the relief was abolished at a time of very low interest rates (and income-tax cuts), the short-term impact was much reduced.

Steve writes:

Andrew--I think the US is closer to 80%. It's astronomical. They'd have to raise the standard deduction by at least $10,000 to keep our economy from tanking after removing the one good thing our middle class has as far as tax incentives.

Eric Krieg writes:

Housing prices might go down a little bit if the deduction were eliminated, but only in the short term. Prices would adjust, and then return to their previous trajectory.

I'm one of those contrarians that thinks that more home ownership is not necessarily better. There is a limited supply of homes in this country, and programs that try to get more people into homes simply drive up the price of housing. It is a zero sum game, one that benefits existing home owners at the expense of the young and those with less income.

I think that getting rid of the morgage deduction and increasing the standard exemption (not the standard deduction, the standard exemption, look at your 1040 to see what the difference is) to something like $10K per exemption would be a wonderful thing. Again, there would be a hit to housing in the short term, so we would want to make this change during an economic expansion, not a recession.

Andrew writes:

US home-ownership: 68% (http://www.census.gov/hhes/www/housing/hvs/q303tab5.html)

UK home-ownership: 70% (http://www.odpm.gov.uk/stellent/groups/odpm_control/documents/contentservertemplate/odpm_index.hcst?n=1563&l=3)

The headline of this article was "Tax simplification" -- the point of removing things like mortgage interest tax relief is not to increase the overall tax take (which can have depressing effect on the economy, as Steve describes), but to make the system simpler, fairer and less distorting. One would expect phasing-out of such a significant tax break to be accompanied by general tax cuts, as was the case in the UK.

Boonton writes:

In the US, many areas have high property taxes. This makes it difficult to own a home for generations like you often see in Europe.

The tax code is complicated because income is complicated. Look at any accounting text book and see how many chapters there are *before* the subject of income taxes even comes up.

For the majority of people, income taxes are simple. Preparing tax returns is one of the biggest rackets out there, really...is it sensible for anyone to ever pay $50+ for someone to prepare the 1040EZ? Even if you itemize your deductions to take advantage of the mortgage interest deduction is it really that complicated? 'How To' tax books are simply rewording the free instructions anyone can get from the IRS.

Yes the tax code has thousands of pages but almost all of them are not relevant to most people. Would your life be any simplier if the thousands of pages relating to mining were eliminated from the tax code?

Generally, if your taxes are really complicated it is almost certainly because your financial life is really complicated. This will be an unavoidable feature of any income tax.

Lawrance George Lux writes:

Boonton,
I disagree with your assessment. The complexity of the Tax Code comes solely from Vested Interest desire to escape taxation. The prolifieration of Tax Credits, Exemptions, and Deductions has crippled the ability to raise tax revenues. The Tax Code must once again be returned to a uniform assessment state, based solely on after-Expense ability to consume. Granting Special credits or Exemptions only reduces tax revenue, introduces tax impact inequality, and actually depresses economic performance. lgl

Boonton writes:

I don't disagree with you Lawrence but I stand by my claims:

1. For most people, the 'complexity' of the income tax code has been wildly overstated.

2. Even in an ideal world income tax code would be complicated simply because income in a multi-trillion dollar economy is complicated. Look at how much space is given to computing income in accounting textbooks *without* considering income tax rules.

Eric Krieg writes:

>>In the US, many areas have high property taxes. This makes it difficult to own a home for generations like you often see in Europe.

Property taxes are yet another deductible item that I think should be eliminated. Why should people with low property taxes (or state income taxes for that matter) be subsidizing those people with high local taxes?

For example, in my experience, Illinois has low property and income taxes (a 3% flat income tax, for example). New York has VERY high income and property taxes. On average, people from New York have higher incomes than people from Illinois. So in this case, isn't the deductibility of local taxes regressive?

Eric Krieg writes:

I agree with Boonton. Defining income is what makes income taxes so complicated. You could have a flat tax with no deductions, and it would still be a lenghty tax code. For example, is a capital gain income? Is a dividend? How about when you sell something you pulled out of the trash on Ebay?

Any tax has a certain level of complexity. We can strive to make a tax simpler, but it might be impossible to make it simple.

I remind you that, if it were up to me, government would be funded with a poll tax only!

Lawrance George Lux writes:

Boonton,
I don't think you will convince me, as I have just finished publication of a Work covering a Simplified Tax Code, but I understand your points. I have always felt minimization of Tax Exemptions is the only method to reduce actual tax rates; the only viable means of securing economic performance and tax revenues. lgl

Boonton writes:

Perhaps but I'm not sure its very meaningful to look at a single line item to determine if it is progressive or regressive. Overall the tax code is clearly progressive. You are certainly better off, from an income tax point of view, being a low or middle incoem Illinois person than a high income New Yorker.

Even looking at the single line item the answer to your question is 'it depends'. How about comparing a lower or middle income New Yorker to a high income Illinois resident? In that case being able to deduct NY's higher taxes is progressive, helping the lower income person at the expense of the higher income person.

Steve writes:

People pay that $50-$100 because they are scared to death of the IRS. They do not want the IRS coming after them and taking their belonings. It has little to do with how complicated the tax code is or isn't.

Boonton writes:

Nonsense. The majority of the people have simple tax returns that typically feature only wage income or wage income plus a home mortgage deduction. Paying someone $50-$100 will do absolutely nothing to reduce your chances of getting taken away to jail. That's like saying people who pay a doctor $50 to apply a band aid to a papercut are afraid of an infection. It's nothing more than wasting money. To the degree that anyone thinks this is necessary because of the scary tax code it is just irrationality.

Eric Krieg writes:

>>Overall the tax code is clearly progressive.

It has aspects of progressivity. But it does not ensure that those with higher incomes pay more in taxes than those with less income (although, probability wise, the high income person is more likely to do so).

Guys like Ross Perot, who derive their incomes from municipal bonds, do not pay income taxes, despite very large incomes. They don't even fall under the AMT.

The tax code is a mess. It is difficult to comply with, it is unfair, and it is inefficient. But man, does it buy votes at election time. The incumbancy success rate wouldn't be 96% without it.

Bob Dobalina writes:

Guys like Ross Perot, who derive their incomes from municipal bonds, do not pay income taxes, despite very large incomes. They don't even fall under the AMT.

Unless, of course, they buy munis that are subject to it, as more and more are. Ceteris paribus, on a 30 year muni, the AMT exemption only "costs" the investor about 20bps...

Boonton writes:

Also you just don't buy municiple bonds. You have to earn some income first to pay for them!

Eric Krieg writes:

>>Also you just don't buy municiple bonds. You have to earn some income first to pay for them!

True enough. But why should the interest on munis be exempt, and from other bonds be taxable?

Most retirees derive their income from investments that they bought with earned income when they worked. Yet the amount of tax paid is not directly tied to the level of disbursement (the income), but to the type of investment. Progressivity is not ensured.

With Perot, why should a man with a net worth of 3 billion dollars be exempt from the income tax?

Eric Krieg writes:

>>Unless, of course, they buy munis that are subject to it, as more and more are.

Well, I guess old Ross didn't buy one of those taxable munis, did he. I bet that he is in the highest tax bracket possible (if he had taxable income), so a taxable muni probably didn't make sense for the man.

>>Ceteris paribus, on a 30 year muni, the AMT exemption only "costs" the investor about 20bps...

I can't say that I am very familiar with the AMT (having never paid it, TurboTax always skips that section!), but my understanding is that it is a 26% flat tax. Is there some standard deduction as well? I'm sure old Ross has so much income that he would be closer to 26% than your average pensioner.

What's up with the Latin? This is an English only site!

At least, English is the language closest to what I'm writing.

Eric Krieg writes:

>>To the degree that anyone thinks this is necessary because of the scary tax code it is just irrationality.

Or ignorance. Low income folks (the people who file the EZ form) can go to TurboTax.com and file for free!

And don't talk to me about the poor being unable to afford internet access. Have you been to your local library lately? Have you seen how many internet terminals they have?

Boonton writes:

I believe the reason behind it is Federalism. The states don't tax interest income from US Treasury Bonds therefore the Fed's return the favor by exempting state bonds. I'm not 100% sure about that, though.

In effect it serves as a subsidy for state borrowing. Assuming this is desirable, is using the tax code the most efficient way to do it? I have a feeling it is....trying to subsidize state bonds by using the Federal budget would be awkward and subject to political infighting.

Say it was desirable to subsidize home ownership. The tax code does seem like a pretty efficient way to do it. You can even keep the subsidy progressive by limiting it to the lower brackets. This would be another reason why reforming the tax code is so difficult. There is little political will to reject the idea of subsidizing some actions. If you do not reject that idea then you are shooting yourself in the foot by not leaving the tax code available to implement it.

Eric Krieg writes:

>>In effect it serves as a subsidy for state borrowing. Assuming this is desirable,

Big assumption.

Let's see. In my experience, municipal bonds have paid for:

1) Sports stadiums

2) Convention centers

3) Athletic facilities (pool, gym, basketball courts. etc.)

4) ice rinks

All nice things, but I fail to see why they should be tax exempt. ESPECIALLY sports stadiums.

Steve writes:

Hmm... Let's see:

Side Roads
Highways
Sewers
Bridges

Without these things, we'd look a lot more like India, China and South America than we do today. Well, with our declining wages and polarization of wealth distribution....ah, nevermind.

Stadiums keep lots of young republicans employed and owners of the "companies" these young Republicans work for (who are also republicans) happy. You should like stadium proposals, Eric!

Boonton writes:

It's not so much a question of whether subsidizing state borrowing is a good idea, its a question of whether you want to preclude yourself from being able to use the tax code from doing any subsidies. Some subsidies are more efficient to do through the budget, others are more efficient to do through the budget. If you commit to a simplified tax code you preclude yourself from this tool.

Lawrance George Lux writes:

You have all mentioned something which is elemental in dealing with the Tax Codes of this Country; this consists in the fact there are several different Tax Codes. The multiplicity of tax levels must be united in some manner, without violation of the Constitution. Failure to do this unification will eventually destroy all Present Welfare transfer payments within a few years. It skews Business marketing profiles, and drives Production to least-Cost extremes. It finally increases pressure for the above-mentioned Welfare payments. Taxes do set Wage rates and levels of effective Government services, mostly in an inappropriate direction. lgl

Eric Krieg writes:

>>Side Roads
Highways
Sewers
Bridges

Without these things, we'd look a lot more like India, China and South America than we do today.
>>

No argument there. That is exactly what munis are for.

So how do you set up a system that allows sewers but disallows abusive items like sports stadiums.

Steve writes:

->So how do you set up a system that allows sewers but disallows abusive items like sports stadiums.

Boonton writes:

Actually even though muni's are tax deductible the states or local gov'ts must still pay them off. Like any other company that borrows money, if investors think a gov't is spending its money wastefully they will charge higher interest rates to reflect that risk.

The simple fact is that if you encourage something you think is good by subsidizing it, you run the risk that the object of your genorsity will not use the gift as well as you would. Think about a rich grandparent who pays for his grandkids college only to see him get drunk every day at parties.

Eric Krieg writes:

>>Actually even though muni's are tax deductible the states or local gov'ts must still pay them off. Like any other company that borrows money, if investors think a gov't is spending its money wastefully they will charge higher interest rates to reflect that risk.

That really isn't the point. It isn't wasteful from the investor's perspective. On the contrary, the demand for tax free investments may be the very cause of the bonds being floated for inappropriate purposes.

It is wasteful from the perspective of a taxpayer that doesn't want to pay ANY excess taxes. If football fans want a new stadium, then they should pay for it themselves and not look to pick my pocket.

Boonton writes:

The town gets no benefit for floating the bonds just for the sake of floating them. Unless the interest rate is 0% it costs something to borrow the money.

I tend to agree with you regarding football stadiums but the fact is the local gov'ts view them more along the lines of a park or highway system. An 'investment' that will bring in revenue beyond the benefit captured by the stadium owners. I'm not sure you can say this is always wrong, either.

Eric Krieg writes:

>>I tend to agree with you regarding football stadiums but the fact is the local gov'ts view them more along the lines of a park or highway system. An 'investment' that will bring in revenue beyond the benefit captured by the stadium owners. I'm not sure you can say this is always wrong, either.

Sure, there are lots of benefits. The biggest benefit is having the incumbant politician's name above the door!

The whole sports stadium phenomonon is a great example of why steps need to be taken to protect capitalism from the capitalists. There is absolutely no reason that any stadium should be built with taxpayer money. The examples of stadiums not coming close to economic expectations(the latest being Miller Park in Milwaukee) is much lengthier than those of successful ones (Camden Yards is the only one that I can think of).

Boonton writes:

Two responses:

1. Voters may want stadiums even if they do not return more than they cost. In fact, if stadiums are always economically unfeasible then the only way to get them is for the gov't to do it.

2. Stadiums are just the extreme end of development schemes. Many cities have tried to bring businesses in by 'restoring' seaports or other areas in order to create tourist attractions. Sometimes this will work and sometimes it won't. If it fails then the taxpayers of the local community should hold their officials responsible.

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