Ask the Experts: If I Could Make One Change to the Tax Code, I Would…
In this edition of our “Ask the Experts” series, we at WalletHub surveyed authorities on tax policy from around the country about how they would choose to alter the tax code in an ideal world.
With tax season in full swing, the economy still floundering, and the federal government’s budget mess yet unresolved, it seems that no one is immune to money woes these days. That’s not likely to change anytime soon either, what with Congress acting like kids on a cross-country road trip and the economic recovery doing its best impression of the University of Maryland mascot.
We can still dream, though, can’t we? You bet. In fact, it’s actually apropos of the season. Not only is it common for those of us who live in the Northeast to begin fantasizing about warm weather and vacation time right about now, but everyone’s favorite baseball team still has a shot at the World Series and a Cinderella has yet to be crowned in college basketball. Heck, Harvard won an NCAA tournament game; we must be dreaming.
So, we asked tax experts from around the country to suspend belief for a moment and imagine a world without lobbyists, polling numbers, reelection concerns, and red tape. If they could make one change to the tax code in such a landscape, with the ultimate goal of improving our economic well-being, what would it be?
The following graph illustrates the general breakdown of their responses, and you can check out each individual's answer below that. Don't forget to weigh in with your own ideas in the comments section at the bottom of the page either!
Type of Change
- Richard Mandel
- Rodney Mock
- Scott Schumacher
- Stephanie Hoffer
- Theodore Seto
- David MacKusick
- James Hardin
- Allison Christians
- Barbara Weltman
- Beverly Moran
- Brad Borden
- Neil H. Buchanan
- Charles Enis
- Clemens Sialm
- Daniel Matthews
- David G. Harris
- William Kulsrud
- David Neighbors
- Douglas Shackelford
- Francine Lipman
- Frank Doti
- Mitchell Franklin
- Gerald Moran
- Grace Allison
- Jay Soled
- John Everett
- John Spry
- Justin J. Hopkins
- Karl Fava
- Kenneth Milani
- Raquel Alexander
- Richard Beck
Our current tax system provides preferential treatment to foreign investors who loan money to United States businesses, but its treatment of equity investment by foreigners is not as favorable. In other words, a foreign person pays less tax to the United States if he loans money to a United States business than if he receives dividends from stock of that business (assuming that no applicable tax treaty changes this result). This is one way in which the tax code encourages our businesses to leverage themselves. In addition, businesses are able to deduct interest that they pay to their lenders. This is a second way in which our tax code encourages businesses to borrow rather than seek equity investment.
Of course, there are non-tax reasons for borrowing as well, and for some businesses, a heavy debt load is impossible to avoid. Still, I can think of no reason why the government should encourage borrowing for borrowing’s sake. United States businesses’ heavy reliance on creditors means that businesses are at risk whenever credit markets become tight. Credit markets contract periodically not only due to normal progression of the business cycle but also because the federal government’s regulation of lending and debt-related securities has been ineffective for some groups of borrowers. When these borrowers default on their loans en masse, the credit market contracts, leaving debt-reliant businesses in a bad position.
So, to conclude, if I could change only one thing in the Internal Revenue Code and my only goal was stabilization of the economy, I would equalize the treatment of debt and equity investments in business. Will this change ever take place? Not likely. Most current businesses have structured their capital with an eye toward the debt preference, and there likely would be significant opposition from institutional lenders and perhaps foreign governments.
Now, whether we should do this through tax increases or spending cuts is actually a much more complicated question than either party really articulates in the public debate. A significant portion of federal spending actually occurs in the form of what are called ‘tax expenditures.’ These are tax breaks given for particular kinds of activities. They run through the tax code, but conceptually they are just as much expenditures as the federal government sending you a check. The problem is that the way these are accounted for is different from direct spending. The direct spending is counted as spending; getting rid of tax expenditure is counted as a tax increase. The real problem that it creates is that these become especially favored expenditure programs for two reasons. One is they are generally perimeter parts of the internal revenue code, and that means that they survive unless Congress changes them, which is different from ordinary spending which has to be authorized annually by Congres. The second part is that inertia is on their side. Inertia is very much on their side.
There is a further problem with tax expenditures that is more subtle and very poorly understood, and that is that the tax expenditure budget published by the government does not fully take into account what’s called the time-value of money. This is simply the value of deferring your taxes. So, if you’ve got a major corporation that can put off paying let’s say $10 billion in taxes for 10 years, that kind of deferral is worth a lot of money. There are many provisions in the code which make such deferrals possible and they are not fully captured in the tax expenditure budget. As a result, when we talk about limiting tax expenditures as a way of balancing the federal budget, we typically are insulating that kind of specially-favored tax subsidy from change. For example, many of the subsidies for the oil and gas industries fall into that category. If you actually look into the tax expenditure budget, you won’t find much there under oil and gas and the reason is that they’re hidden.
• Permanence: Changing tax rules create uncertainly, which makes it impossible to plan ahead.
• A single tax: Currently, for example, a small business owner may have to figure all of the following taxes: Income tax, alternative minimum tax, self-employment tax, additional Medicare tax on earned income, and additional Medicare tax on net investment income.
• Lower tax: Every dollar a taxpayer sends to Washington is one less dollar available for spending, saving, paying for college, etc.
To solve the problem, Congress should take steps to eliminate loopholes that allow wealthy to exclude items of income, tax certain deductions, and pay a lower tax rate. Such an equitable tax system will help ensure that the government has sufficient resources to provide necessary services and that the middle and low income households have sufficient resources to cover basic needs.
Another item that I think might help in the economy, probably not so much now since the housing crisis has pretty much subsided a bit, but I would think that if a person sells their personal residence for a loss there’s no tax deductions at all for that. So people are walking away from their homes and things like that. I think that there are two factors there: I think that people should be allowed a certain capital loss deduction that is capped at a certain amount, so that would make them more willing to go and take a loss on their home, and also I think that somebody that walks away from their home should not receive much relief from the provisions of the code that deal with cancellation of indebtedness. I think if you want to go and have your debt cancellation tax-free, then I think you should be able to stay in the home and start paying something in the mortgage. The idea here is that just walking away and abandoning the homes really does harm to the urban areas. It causes blight and a lot of homes are in disrepair, and I think that is just bad for the various communities.
U.S. multinationals engage in tax planning so that their “offshore” profits are not taxed in the U.S. until repatriated to the U.S. Because U.S. rates are so high, U.S. multinationals have a very strong incentive to keep these profits offshore and reinvest the profits overseas. According to some estimates, these offshore profits are about $1.4 trillion. Apple has been receiving a lot of negative press in the past few weeks because Apple reportedly has over $100 billion in offshore profits that haven’t been taxed in the U.S. As you may know, Tim Cook, Apple’s CEO, recently testified before a congressional subcommittee that the corporate rate would have to be reduced substantially before Apple repatriates its offshore profits.
In short, if corporate rates were reduced substantially (or eliminated altogether), much of the $1.4 trillion in offshore profits would make its way back to the U.S. and be reinvested in the U.S. (e.g., more hiring of U.S. workers, more investment in R&D, facilities, equipment, etc.) That would improve the U.S. economy greatly.
In my opinion, Congress may pass a token cut to the corporate rate (5% or less) in the next few years. But I think the chances of Congress reducing the rates substantially (by 15% or more) is highly unlikely.
Two examples I use in my classes to illustrate these distortions hearken back to communist Russia (and note communism is neither more nor less than a set of tax rates, “from each according to their ability” is a 100% tax rate, and “to each according to their needs” the distribution of those taxes). The first example is taxi cabs. The government decided that cabbies needed more incentive as they were seen lounging about rather than driving. The government mandated a per-mile supplemental payment. In short order, cabbies stopped lounging about and were barreling down the streets as fast as possible, not wasting time to stop and pick up passengers, to max out their per-mile payments. The second is chandeliers. The government decided that more chandeliers should be made, so they arranged a supplemental payment to chandelier manufacturers measured by tonnage. They didn’t sell any more chandeliers, but they made them so heavy that they started pulling ceilings down in houses.
These are distortionary effects. There are direct compliance costs, the costs of paperwork, hiring attorneys and accountants, etc., that are estimated at 40% of the tax collected. But, this grossly understates the opportunity cost of diverting talent to tax planning and compliance, and away from useful work. I tell my students – we are all in a useless business – highly paid, but only a burden. That is tax planning contributes not a single dime of real value to anything. But, because complex and expensive taxes can be legally avoided by strategic planning (the distortions above) demand is high, the job is very hard due to complexity, and so it pays phenomenally well. It does attract some of the sharpest minds in the world, which you almost have to have to deal with tax matters for multinational corporations. One of my former students doing international tax work put in over 2,500 hours a year and bills out at $1,000 per hour – you do the math. Think how much better off we all would be if those brilliant minds were devoted to something useful – like curing cancer, or even sweeping sidewalks as more societal value would be created by that than by tax planning.
As a practical matter, Congress is hanging too many ornaments on this Christmas tree and it’s about to collapse under its own weight. I’ve been teaching and writing about federal income taxes for almost 40 years and the law is just too complicated for the man on the street. For others, no one knows when the alternative minimum tax will strike. We currently have two systems: the regular tax and the AMT. Does that make any sense? If you want real tax reform do what several have suggested: eliminate withholding. When people start writing those big checks on April 15, you would see real reform and real change. Only then will people understand what they are really paying.
The tax code now strongly favors capital gains — increases in the value of assets, such as stocks and real estate — over ordinary income. Not only is the capital gains tax rate far below the top tax rate on ordinary income, but taxpayers can delay paying taxes until they realize their capital gains (usually when they sell assets).
In addition, where I am in Las Vegas, these very, very large refunds attract unscrupulous tax preparers because they want a piece of that, too. So you have everybody and their neighbor saying they can prepare a tax return and not doing it accurately to get a piece of that refund, and it really creates a nightmare for these arguably innocent victims – families who just want to get their tax returns prepared and their refunds. If it could come through their paycheck weekly or monthly through some sort of reverse withholding, I think that would be better for tax payers and better for our economy.
In other words, I’m saying the mortgage interest deduction and the real estate tax deduction, that’ll stay. And a lot of other parts of the tax code – the business deduction – they won’t touch small or even any big businesses in terms of being able to allow any appropriate deductions related to that business. That’s complex, complex accounting that won’t be touched. The things that I think should be fixed and hopefully will are the Alternative Minimum Tax, the AMT, which is nonsense. It’s ridiculous; it’s lost its usefulness – very complex. Get rid of it. That’s number one. Number two: all of the various thresholds that if your income is above a certain amount you can’t take advantage of whatever it might be – IRA deductions, charitable deductions, itemized deductions – all the numbers are different for each of the different laws. Even a brainiac that has an incredible memory could never remember all of the various numbers. … It’s nonsense, absolute nonsense. That’s where the tax law can be fixed.
The basic structure of income and deductions that has been around for 100 years is pretty damn good. We have an income tax system that I think does its job. It soaks the rich and doesn’t affect the low-income [consumers]. Overall, it’s good but it needs to be cleaned up. And I think that’s going to happen. And when that happens – I think at the same time – Congress is going to realize, “Ok, let’s beef up the budget to the IRS so they can get more money to help the budget deficit. So, again, if this is going to happen and when is a tough call because of the craziness in Congress between the Republican House and Democratic-controlled Senate.
Businesses currently in the U.S., or new businesses, have no obligation to be here or stay here. No different than an individual car shopping; typically, one will purchase the car that offers the best deal and value for the dollar. Businesses are obligated to shareholders to do the same thing. They are going to operate where they can get the best value, and this means a mix of the lowest tax rates and the best pool of qualified workers.
The U.S. can still provide a qualified workforce, but cannot come close to competing when it comes to taxes. Instead of constantly draining current business with increased taxes and fees, we need to simplify and lower taxes. If countries as developed as us can tax corporations at a 10% rate, where the same here would be a 39% rate, we need to be taxing businesses below 10%, as well as cutting state taxes, property taxes etc. This will increase the demand to come here, which will increase hiring, improve jobs and drive up wages/benefits offered as the demand to hire the most qualified increase.
Higher wages = more taxes paid into the system. More companies = more overall taxes paid into the system. We need a 100% focus on lowering tax rates across the board, simplifying the code to have no loopholes and increase the number of businesses that pay taxes.
This is standard economic advice, but except for rare events like the 1986 Tax Reform Act, politicians tend to prefer higher tax rates while retaining the ability to hand out lots of tax preferences.
It’s my belief that the policy to tax corporations based on the worldwide income drives a large portion of this variation. Some firms can more easily locate assets, such as patents, copyrights and other intangibles, abroad in low-tax jurisdictions while others cannot. This allows these firms to shift income from high-tax to low-tax jurisdictions, reducing the total worldwide tax burden.
Hence, the recommendation I would make (as bold as it may be) is to move to a territorial system, like the rest of the world. That would greatly simplify the tax code, eliminate distortionary behavior and result in a more fair system.
Of course, if I had my choice, I’d eliminate corporate taxation altogether. Some people seem to think that we need corporate taxation in order to tax the ‘rich.’ However, corporations are not people. The largest shareholders of many corporations are public pension plans. So, by taxing corporations we are basically levying taxes on public servants, employees, and customers. If the government wants to tax the ‘rich,’ it should do so at the individual level.
There has been the long held ‘pillar’ that low capital gain rates stimulate the economy. The largest holding of capital assets are within household of the highest net worth. The argument has always been people would not invest their money if capital gain rates are high. This is ludicrous. Investors are looking to save taxes but their investment decisions are made on risk and rates of returns. If tax rates are constant on two separate investments then the tax is not part of the investment decision only risk and rate of return. An investor is not going to put their money under the mattress. If they do not want the low rates of return from a bank account they may accept higher risk of the stock market but also on the expectation of higher returns. The decision to seek a higher rate of return is not tax motivated it ‘rate of return’ motivated. If ordinary income rates were lowered for wage earners and capital gain rates were increased for investors this could be done in a way that would be revenue neutral but would provide a dramatic uptick in the economy. Wage earners are more apt to spend extra dollars coming home pay check by pay check. Obviously more spending will stimulate the economy as we saw last year with the lower social security tax that created higher tax home pay. A high net worth household is not going to spend into the economy dollars saved from lower capital gain rates.
I believe in low tax rates and am lucky that I am always falling into the highest tax bracket. Saying that, I benefit from low capital gain rates so I am not suggesting this as a finger pointer. I am suggesting this as it would work. Sadly this reform will never take place as capital gain tax rates have always had a favored place in the tax code for high income, high net worth taxpayers. It’s too bad that too much of the tax code is built for select groups within the economy.
• Consistency would be welcomed by the business community since the helter-skelter movement of rules, regulations and rates tends to create confusion and in, some cases, a let’s-wait-on-the-sidelines [approach] until Congress figures what they are going to do tax-wise.
• Predictability is another feature the business community would welcome. With so many proposals being touted by a variety of proponents, the lack of predictability develops a sense of “who knows what’s going to happen?” and the related non-action by the business community while Congress decides which route, if any, to take.
• Added incentives to invest. Capital spending is a strong driver of economic growth. When spending on machinery & equipment and other long-lasting items stagnates, that ripples through the economy.
During the Clinton years and part of the G.W. Bush years, the above factors were more-or-less present. That began to change during Bush’s final term and has continued due to the continual wrangling that is a characteristic of the current Congress. So what are the chances of the CPA proposal occurring? The Chicago Cubs (my favorite baseball team) have a better chance of winning the 2013 World Series than the proposal described above.
Image: Keith Bell/Shutterstock
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