April 15, 2014
How to Control the IRS
By Jon N. Hall
Americans despise and fear the Internal Revenue Service. The IRS has been discriminating against, and has even persecuted, conservative groups. The IRS will soon be policing ObamaCare compliance with thousands of new agents.The IRS is no longer just a collection agency. The IRS even has its own SWAT teams. Something needs to be done about the IRS.
The way to get control over the IRS is through tax reform. Several tax reform plans, such as the one from the Bowles-Simpson commission, have proposed the same thing: ridding the Tax Code of its exceptions. Exceptions are the exemptions, deductions, credits, write-offs, loopholes, and gimmicks that allow taxpayers to pay less than their tax rates would indicate.
These plans are headed in the right direction, but they don’t go far enough. What they should recommend is the complete elimination of all exceptions. That would allow for the lowest rates possible that would still bring in the same revenue. Eliminating all exceptions dictates setting the new tax rates to their current effective rates, what folks actually pay. So if one currently has an effective income tax rate of, say, 10 percent, under the new system that taxpayer would have a statutory income tax rate of 10 percent. The new low rates would be levied against every dollar of income.
I’ve written about this tax reform idea here, but I didn’t give readers an idea of what their new tax rates would be. People may be surprised at how low their new rates would be under this idea.
Consider these numbers:-6.5, -1.0, 3.0, 6.0, and 14.1. Those numbers are the Effective Tax Rates for Individual Income for the five quintiles for 2005; (see page 6 of this CBO report). Now consider that middle number: 3.0. It’s the average effective tax rate for the Middle Quintile. Notice that all the above effective tax rates except the highest one are below 10 percent.
With our progressive tax system, even middle-income earners now have multiple statutory tax rates. One’s first dollars are taxed at zero percent and one’s last dollars might be taxed at 28 percent. Rather than paying multiple rates, what would be so awful about those making the median income paying a flat 3 percent federal income tax rate on every dollar of their income?
It’s hard to say exactly what the new tax rates under this proposal would be, but currently the lowest statutory income tax rate is 10 percent. From this Tax Foundation chart for 2010, we see that the average effective income tax rate for all taxpayers was 10.1 percent. And from this Peter G. Peterson Foundation chart for 2011, we see that an average effective income tax rate of 10 percent didn’t kick in until incomes got into the top 10 percent.
So it’s safe to say that for the bottom 90 percent of income taxpayers that they would have new statutory income tax rates below 10 percent and the median income earners would have a rate of around 3 percent.
Earlier this month, I wrote an article about the IRS’s Form 1040EZ, and how those who use that form pay the maximum tax for their incomes. The article showed that while the Middle Quintile had an average effective income tax rate of just 3 percent in 2005, an unmarried taxpayer earning the average pretax income for that quintile who used the1040EZ would have had an effective income tax rate of 15.8 percent, more than five times the average.
Under the current tax regime, an unmarried individual filing the 2013 1040EZ would have an effective tax rate of below 10 percent only if his total income were below $38,950. In Peterson’s chart, that income would place one in the middle of Middle Quintile. That would lead one to conclude that someone with a middling income can have an effective tax rate equal to that of someone at the bottom of the top 10 percent of earners.
Taxpayers who currently don’t take advantage of the myriad exceptions in the Tax Code, including all 1040EZ filers not taking the EIC, would get a tax cut under the system I’m proposing. Only taxpayers whose use of exceptions is greater than average would get a tax hike.
To keep taxpayers paying closest to what they’re currently paying, there would need to be more tax rates than the current seven rates. But that need not complicate. Consider the 2013 Tax Table, it goes on for 12 pages and lists tax bills for incomes up to $100,000. There are 2,062 sets of tax bills. New tax bills that reflect an expanded set of new tax rates could easily replace the Tax Table’s current array of tax bills.
If a transparent, streamlined tax system that makes tax compliance as simple as it can possibly be is attractive to you, don’t hold your breath. There are powerful forces arrayed against such change, and some taxpayers think they can’t survive without their special exceptions. On April 4, George Will’s column “A tax reformer’s uphill push” put numbers on the dollar value of certain exceptions, such as “the deductibility of mortgage interest payments, a $70 billion benefit disproportionately benefiting affluent homeowners.” (Why don’t renters get to deduct their rent?)
Americans want their tax exceptions. Why pay the full freight when others will make up the difference? If the elimination of all exceptions in the tax code were being considered, throngs would descend upon Congress to argue for each exception. Eliminate the other exceptions if you must, but leave mine alone. They’d demand an exception be made for their exception.
One could make a case for just about every exception in the TaxCode, but then we’d never get tax reform. The reason to get rid of all exceptions in the Tax Code is because if even a single one remains, more exceptions will be added. If Congress wants to help certain enterprises, fine, but do it outside of the Tax Code.
Take the write-off for purchasing the Tesla, the all-electric sports car. Those who would buy the ultra-cool Tesla would do so regardless of whether there’s tax deduction for doing so or not. On March 30, 60 Minutes aired a fascinating segment on the founder of Tesla, Elon Musk. Mr. Musk is an entrepreneurial visionary; America could use scores more just like him. But that’s less likely given America’s byzantine tax system.
What those who benefit from tax exceptions need to realize is that they’re being subsidized not just by the super-wealthy who get hit by higher tax rates, but also by the middle class who don’t use exceptions. Now, I believe in a system of graduated rates, where lower-income earners have lower rates. But after lower rates have been awarded, that should be the end of it. Taxpayers with identical incomes should have identical tax bills. Democrats are now droning on ad nauseam about equal pay for equal work; but what about equal tax bills for equal incomes?
If one isn’t visited by an IRS SWAT team, one still might have a healthy dread of our federal collection agency. Although it is an utter perversion of America’s system of justice, if the IRS says you’re guilty, you will have to prove your innocence; if the IRS says you owe them, you’ll have to prove that you don’t owe them. So you had best save every record of every money transfer you receive, and for the rest of your life.
The problem with our federal income tax system is the exceptions in it.The mission of Lois Lerner’s division at the IRS is to police eligibility for exceptions. By eliminating all exceptions, the IRS could be seriously downsized. Indeed, Lerner’s entire division could be scrapped.
By eliminating all the exceptions in the Tax Code, the whole focus of the IRS would change. Rather than spending so much time determining whether taxpayers get to pay less in taxes, the IRS would be focusing on whether Americans are reporting all their income. By doing that, the IRS might even be able to scrounge up some new revenue.
The Tax Code is the means by which the government tries to control us. The Supreme Court could justify ObamaCare only by invoking the power to tax. Limits need to be put on that power or the IRS will run amok. If they get power, Republicans’ first order of business should be to radically simplify the Tax Code and to fundamentally transform the IRS.