Why You Aren’t Supposed to Understand the Tax Code

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Fri, Apr 17 - 9:00 am EDT | 3 years ago by
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    Free Radical - Taxes

    Another tax day has come and gone. This time around I noticed a number of stories pointing to a recent survey showing that most of the public doesn’t know much about tax returns and personal finance. That’s no big surprise given the outrageous complexity of the U.S. tax code where it takes more than 200 pages just to provide the instructions for an individual tax return.

    Even the supposed experts can’t get it right. The IRS ignores most of the calls they get from taxpayers, but when one of their agents does pick up the phone there’s a good chance they’ll be providing the wrong information anyway in response to their inquiries. Past reports have indicated they answer incorrectly as much as 30 percent of the time. Nor can Americans simply rely on tax preparers to get the job done correctly, as they are also reported to have high error rates. The IRS’s free preparation assistance service for the elderly is not much better.

    When even those who make their living enforcing or complying with the tax code can’t understand it, what hope is there for the public? Clearly, the problem is not with them; it’s with the tax code.

    Sadly, tax code opacity and complexity is seen as a feature by the ruling class. The problem has been understood for decades yet only ever gets worse. Nothing gets done about it because politicians and the parasite class benefit tremendously from the complexity of the tax code, and as far as they are concerned, the less that you know is being taken from your wallet, the better.

    First and foremost, a complex tax system makes it easier for politicians to reward their friends and allies by auctioning off loopholes in exchange for campaign dollars. K Street is filled with lobbyists that make a mint off of securing favorable tax treatment for special interests. These deals only work because no one on the outside can possibly track what any particular change to an obscure section of the byzantine tax code means in the real world.

    Another significant political benefit of the withholding system is that it reduces the taxpayer anger toward Washington that would otherwise be felt during tax season. Paradoxically, some taxpayers even look forward to tax day because they will get a refund! What’s not great about getting money, right? Nevermind that it was money they worked for in the first place, and that by overpaying the IRS throughout the year they’ve effectively reduced the value of their earnings (there’s no interest from forced loans to the IRS). Yet taxpayers still perceive the influx as a positive event, and that’s good for politicians who like to tax and spend.

    Some taxes are actually designed with dishonesty in mind. Payroll taxes that fund Social Security and Medicare obscure half of their impact on taxpayers by creating a false division between employer and employee contributions. In reality it’s all paid by the employee. An employer cares only about the total cost of an employee in their budget; what percentage goes to wages, non-wage benefits like health coverage, or taxes, simply makes no difference. Force the cost of one to go up and the others will have to go down.

    So workers simply make less money to fund the “employer share” of the payroll tax. To find the true tax rate for an individual you would have to double their Social Security and Medicare contributions (to be consistent, you’d similarly have to add that to the total income to calculate their true income tax rate). So instead of paying 6.2 percent and 1.45 percent for Social Security and Medicare respectively, they’re actually paying 12.4 percent and 2.9 percent. That means that before income taxes even enter the picture, payroll taxes have gobbled up over 15 percent of a worker’s earnings.

    Hurts once you know about it, doesn’t it?

    Even inflation caused by government printing of money works to hide tax increases from the public. Because the system is progressive and statutory rates go up as workers earn more, inflation can force taxpayers into higher brackets through what’s known as “bracket creep,” even as the real value of their earnings stay the same. Every so often rates would have to be “cut” just to keep the burden on taxpayers equal over time. This is a convenient fiction for lawmakers who love government because they get the benefit of tax increases without having to vote for them.

    Likewise, they can demand concessions in exchange for the fake cuts needed to prevent bracket creep. Over the years, this has meant that whenever Republicans have sought to lower the burden on the economy by cutting taxes, they have had to concede to Democrats ever growing carve outs for lower income workers from the income tax altogether. And each time this is done the code necessarily gets more progressive as the upper incomes receive a relatively smaller percentage reduction in order to satisfy class warfare demands.

    While it’s good that the tax burden for many has been reduced because of this, doing so in such a manner has created a situation where much needed reforms are almost politically impossible. The tax base has been eroded to the point that it most resembles Swiss cheese, and any attempt to move to a fairer, less destructive system (a broad base and low rates) necessarily means both a statutory increase on the half of the country currently exempted from income taxes, and cuts for the upper brackets. That’s a tough sell indeed.

    To be sure, there are potential solutions to that conundrum. The first is recognizing that there’s a difference between the statutory tax rate and what is actually paid. Closing loopholes would allow rate cuts to be offset. Also, they could pair income tax reform with entitlement reform and reduce payroll taxes at the same time as the income tax is flattened and broadened. And with Social Security and Medicare heading toward fiscal disaster, that’s going to have to happen anyway.

    The ideal replacement to the current corrupt and inscrutable system would be a single, low rate imposed at just one point of the earnings cycle. Whether that be a flat tax, national sales tax, or VAT, doesn’t really matter. They are all fundamentally doing the same thing by simplifying the code and eliminating penalties on productive behavior, such as the double taxation on savings and investment.

    This would allow taxpayers not only to file a single, postcard sized tax return each year, but also to finally see just what their government really costs them. That’s important because hiding the true cost of government programs distorts voter preferences in favor of bigger government. Eliminating loopholes and making the tax code understandable for all would also reduce corruption by removing a popular source of political favoritism.

    Brian Garst is a political scientist, commentator, and advocate for free markets and individual liberty. He also blogs at BrianGarst.com and you can find him on Twitter @BrianGarst.

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      • Bordeaux Vixen

        if it was imposed all at once, most folks would have a serious cash flow issue. not a good solution buddy.

        • Kain Yusanagi

          Which is why he states it is a problem and would be best done gradually, in stages.

        • Bordeaux Vixen

          “The ideal replacement to the current corrupt and inscrutable system
          would be a single, low rate imposed at just one point of the earnings
          cycle.”

          Er…

        • Kain Yusanagi

          And now when you read the rest of the article, talking about how that done all at once would ruin things…

        • Bordeaux Vixen

          I’m pretty sure I’ve read this correctly, maybe the writer could chime in?

        • http://www.briangarst.com/ Brian Garst

          It wasn’t really the point of the piece, but I did bring it up so I’ll try to respond as best I can.

          Though, I admit I’m not entirely sure I understand your critique. Any change I’m proposing would be revenue neutral (at worst, I think the government could do to take in less), so no more money would be taken out of the economy. The goal is to replace the most economically destructive taxes with the least economically destructive taxes, with a consideration made also to not raising any individual burden significantly, which I elaborated on in the piece.

          Let me back up. There are two fundamental ways that taxes impact the economy and the people in it. The first is by reducing its total resources. This is what Keynesians tend focus on most, which is why they look to “stimulate” the economy through injections of cash. The other, I’d argue much more significant, impact that taxes have is through how the code changes behavior. All I was suggesting was minimizing the damage from the latter, which ought to be the goal of any tax system – to extract just as much as the government requires while doing as little harm to the economy as possible.

        • Bordeaux Vixen

          that makes perfect sense. thanks for elucidating that for me. :)

      • bigmaq1980

        “recognizing that there’s a difference between the statutory tax rate and what is actually paid.”

        This is probably the biggest obstacle. Even though many people ought to find this intuitive (e.g. child tax credits, mortgage interest deduction), the “progressiveness” of the rate brackets seems to be the focal point.

        Would like to see stats on the net tax rate by decile of gross income for individual tax filers. Any ideas?

        Seems that Grover Norquist had similar idea – trading loopholes for rate reductions, as the most politically acceptable first step in tax reform.

        Ultimately, would prefer to see it all be replaced (in whole) by a National Sales Tax.

        Would also add the concept that only transactions on which this tax was paid are enforceable by law.

        • Justin$Man

          I just want to pay less – can’t we just decrease the wild bonuses salaries and pensions of the men on top?

        • bigmaq1980

          You don’t have to pay less. You can make more…Convince your family, friends, or anyone you know to short the stocks of those companies, because, in your judgement, those bonuses, salaries, etc. are poorly invested, producing a net negative value to the shareholders.

          I do see an agency problem related to executive pay, but this is a separate problem from the complexity (and subject to adverse political influence) the tax code has for individual income taxes, however.

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