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.
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