Simplifying the Tax Code?

I’ve heard people from both the left and the right call for simplifying our complicated tax code. So why does it seem like all the discussion these days is about making it even more complicated?

President Obama has been touting the “Buffet Rule,” which would require Americans who earn at least $1 million to pay a minimum income tax rate of 30%. The rates for regular wages are already higher than that, but since a lot of millionaires earn most of their money from investments, which is taxed at a lower rate, combined with a variety of other tax breaks, a lot of millionaires pay an overall rate lower than 30%. Thus, the hoopla about Warren Buffet paying a lower tax rate than his secretary. Thus, the “Buffet Rule.”

But apparently there aren’t too many millionaires cheating the system too badly, because the Buffet Rule is supposed to add less than $5 billion a year to government revenues (remember, we’ve been running deficits over $1 trillion – or $1,000 billion – for several years and are projected to do so for several more). As the Obama administration itself admits, this is less about reducing the deficit and more about the vague concept of tax “fairness.”

There are reasonable arguments to be made that the rich have benefited the most from recent tax cuts and that we should raise their rates as part of overall budget reform. But the “Buffet Rule” just adds another layer of complication to the already existing web of rates and credits and deductions without doing much to reduce the deficit. It’s like another Alternative Minimum Tax – a complicated layer that Congress ends up adjusting every year so inflation doesn’t make it affect more taxpayers than originally intended.

The “Buffer Rule” is popular with voters, but the lower majority will always support taking more of the upper minority’s money. Even if we’re going to do that, let’s do it by changing the existing rules and eliminating subsidies and loopholes – not adding a new rule that tries to cancel out all of the other ones. And while we’re at it, we need to remember that the top 1% already earn almost 20% of income but pay almost 40% of income taxes, and if we only increase our reliance on the rich, we just increase the “missing millionaires” problem.

Not that any of this discussion really mattered – Republicans just blocked the measure in the Senate, and the House wasn’t going to pass it anyway.

But that’s not the only tax complication Obama’s been talking about lately. A few weeks ago Republicans shot down his attempt to end “big oil” tax breaks. In general, I don’t like subsidies and tax breaks for specific corporations and industries – they waste money, distort the market, favor established businesses and protect them from innovative competition, etc, etc. So if “Big Oil” is getting “tax breaks,” what’s not to like about stopping that?

Well, unfortunately, it’s not that simple. As Bob Murphy explains, the current tax break for oil companies is part of a larger tax break that affects lots of companies and had various reasons for being introduced. Obama’s plan wasn’t to end the overall “loophole,” but to end it just for the rich, profitable oil companies. In other words, a “loophole to a loophole.” Or yet another layer of complication to a complicated tax code.

However, Obama still has a chance to simplify the tax code. David Leonhardt in the New York Times warns of a coming “Taxmageddon” in January 2013, when a few extended tax breaks will finally expire – namely the “Bush” tax cuts and the payroll tax cut, both of which affect all working Americans. The easiest way to simplify the tax code right now is to actually let these expire.

There are still multiple political scenarios that end in these cuts being kicked down the road again, but I’m one of the “optimists” Leonhardt talks about who is not afraid of a political stalemate that ends these tax cuts and forces various spending cuts that are scheduled to kick in (This is partially due to my anti-Keynesian bias that it is not ultimately harmful, even in today’s economy, to withdraw government spending from the market.) The pre-Bush economy handled pre-Bush tax rates just fine, and if we can really combine that with reductions in government spending, that will give a double whammy to the deficit.

This is why many claim that the best thing for the deficit is to “do nothing.” I believe we need slightly higher tax rates for all and drastic spending cuts for all. I’m too cynical to believe that Obama and Congress won’t find a way to delay both tax hikes and spending cuts yet again, but in today’s hyperpoliticized environment, I can certainly dream.