Taxpayer's Tab: Legislative Spotlight

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Legislative Spotlight: Tax Reform

In less than two weeks, taxpayers across America will be required to submit their federal income taxes for 2013. As painful as it is for many to find out how much they are required to pay, the process of figuring that out can be just as distressing. As the Tax Code becomes increasingly complex, the compliance burden on taxpayers increases. Last year, Americans spent $34.1 billion and 6.7 billion hours preparing their taxes, according to an annual study by NTUF’s sister organization, the National Taxpayers Union.

Many citizens’ filings will inevitably be flagged for further review or audits by the Internal Revenue Service (IRS): some are selected randomly and others because they paid incorrect amounts, whether they did their own taxes or used a professional service, like Turbo Tax or an accountant. More taxpayers could fall into this snare: the budget shows the IRS is spending just over $5 billion on enforcement this year and requests to raise that by $355 million for next year. Enforcement staff would increase from 42,944 to 45,910 (see pages 1076 and 1077).

To address these compliance and complexity concerns, some legislators are proposing not only marginal changes to the current system but also complete, fundamental reforms of the ways the government assesses and collects taxes. In this special edition of The Taxpayer’s Tab, we look at some of the proposals to create a more efficient system and how those bills could affect spending, principally at the IRS.

The Current System

NTUF has been researching the spending impact of tax reform since the BillTally project was created in 1991 and, this past July on Milton Friedman Legacy Day, we surveyed taxpayers on what system they would support if given the chance to fix federal tax collection. According to the unscientific results, just two percent of the respondents would keep the current system as is.

The United States currently has a hybrid progressive income-based tax system. This means that households making more than others are required to pay a higher percentage of their income to the government. We call it a hybrid system because a true progressive tax would increase the proportion of one’s income paid to the government for each dollar earned, whereas in today’s system, there are seven brackets that represent various ranges of income, each charging a relatively higher tax as the income range increases.

As mentioned above, there are thousands of reductions available to filers that can decrease their tax burden. Along with deductions that reduce taxable income, taxpayers can claim credits, which reduce their tax liability. There are also “refundable” credits, which can be claimed in excess of one’s tax liability, thus resulting in increased federal spending. These options in the current system ease the tax burden of many Americans but they also cause more complexity, which in turn increases compliance costs of time and money spent preparing returns. Some credits have been carved out for entire sectors or only targeted for a select few; these are typically referred to as tax expenditures or “loopholes”. 

In addition to taxes on overall income, many filers are also subject to payroll taxes (used to finance entitlement programs such as Social Security and Medicare) and investment taxes (such as capital gains and dividend).

The latest push to reform the current system was drafted by Congressman Dave Camp (R-MI) but was not formally introduced as legislation. Called the Tax Reform Act of 2014, the measure would cut the number of individual brackets from seven to two (at ten and 25 percent levels) and would cut down on the number of individual credits while expanding the eligibility for the remaining deductions. A majority of Camp’s provisions would strictly change revenues (and are thus not counted under NTUF’s BillTally methodology), but some measures could affect federal spending, including:

• IRS Limits: With the simplification of the Tax Code, the IRS might not need as many agents thus permitting a reduction in personnel and enforcement costs. The measure would also require the IRS to reduce waste, fraud, and abuse but such measures may increase spending or not reap a net savings as predicted.
• Infrastructure Funding: The plan would dedicate $126.5 billion over the next eight years “to fully fund highway and infrastructure investment” through the Highway Trust Fund. Highway funding is up for reauthorization this fall. In recent years Congress closed highway funding shortfalls by transferring tens of billions of dollars from the general fund.

Find more information on the Tax Reform Act of 2014 at the New York Times, the Tax Foundation, The Wall Street Journal, and Red State.

A Flat Tax

The Bill: S. 173, the Simplified, Manageable, and Responsible Tax (SMART) Act

Savings Per Year: $85.8 billion (one-year savings)

Senator Richard Shelby (R-AL) reintroduced the SMART Act at the beginning of the 113th Congress. His plan would reform the current tax system in a more fundamental way than Camp’s draft proposal. The multi-bracket system would be replaced with a single 17 percent tax that would apply to all individuals making over $13,410 and households making $17,120 or more. S. 173 would also repeal all income tax credits.

Generally, NTUF scores legislation assuming passage upon introduction. Using data from the FY 2014 budget, NTUF scored the bill as an $85.8 billion one-year savings*. If the bill was enacted this year, the savings would total $86.8 billion. The cuts would result from the repeal of refundable tax credits, which result in outlays to the extent the credits claimed exceed a filer’s tax liability. It is likely that the SMART Act would also have budgetary effects on the IRS from reduced staff and complexity but it is unknown at this time exactly how the agency would be affected.

* The $85.8 billion figure is the final score of the SMART Act and will be recorded in Senator Shelby’s and any supporters’ pending BillTally member First Session report.

A Fair Tax

The Bill: H.R. 25/S. 122, the Fair Tax Act of 2013

Savings Per Year: $19.4 billion ($96.9 billion over five years)

Instead of basing taxes on how much a household makes, Congressman Rob Woodall (R-GA) and Senator Saxby Chambliss (R-GA) propose a system that would levy taxes on consumption of goods and services. Supporters argue that a consumption tax is more consistent than income as a source of revenue for the government. Moreover, the multitude of credits and the complicated reporting requirements under the current system make it easy to avoid paying -- unintentionally or not -- some or all of one’s entire tax obligation. Today’s system also imposes imbedded costs on a product’s sale price, meaning that the final price consumers pay reflects a number of manufacturers’ taxes imposed at various phases of the production cycle and which are ultimately passed on to consumers; these taxes are estimated to be approximately 23 percent.

Though designed to be revenue neutral, the bill would affect spending in a number of ways. H.R. 25 would eliminate the income tax system in favor of a 23 percent sales tax on all new goods and services, and the IRS would eventually be eliminated. Revenues would be collected at point of sale and businesses would send money to the government through a new collection agency that would replace the IRS.

To offset the taxes imposed on consumers for purchases of necessities (such as bread, eggs, and certain clothing, as defined by the Department of the Treasury), the government would send each household a “prebate” payment.

In early 2013, NTUF determined that H.R. 25 would cut $85.8 billion in outlays from refundable tax credits, and would cut $12.1 billion by FY 2016 through the elimination of the IRS. However, mailing the monthly “prebate” could result in $241 million new annual costs (this could be lessened if other means of remittance are implemented). As the IRS is phased out, the smaller agency (mentioned above) would manage the prebates. NTUF assumes it would be similar to the current Tax and Trade Bureau, would be a $102 million new cost each year. Using update figures from the FY 2015 budget, NTUF determined that the Fair Tax Act would reduce spending by a net $97.2 billion if enacted in 2014.*

* The $96.9 billion five-year figure from 2013 is the final score of the Fair Tax Act and will be recorded in Rep Woodall’s and any supporters’ pending BillTally member First Session report.

Conclusion

Even with these and additional policies on the table, little progress has been made in reforming America’s massive and complex Tax Code. Other ideas include H.R. 2393, the American Growth & Tax Reform Act of 2013, which would require the Department of the Treasury to develop a new progressive consumption tax, and a one-percent national transaction tax that was examined in the Tab in 2012 (both proposals were sponsored by Congressman Chaka Fattah (D-PA)). A report on all major tax reform proposals in the 113th Congress is available through the Congressional Research Service.

Americans have been enduring a tax system that is too bloated and too complex for too long. This April, taxpayers face a daunting array of new difficulties and compliance burdens under the so-called Affordable Care Act. But the current tax regime also presents a challenge for the IRS, the enforcer of the tax laws. Just this week, the agency's Commissioner made a rare plea for simplification of the Tax Code. Complexity not only adds to the enforcement costs, but also diminishes the IRS's ability to supply basic taxpayer services. A well implemented tax reform could not only make life easier for taxpayers, but could also reduce the size of the government.

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