Many would agree that less is more. But does that ring true for tax reform? The GOP seems to think so. In their 2016 tax blueprint, House Republicans traced the 30-year growth of Federal tax law from 26,000 pages to approximately 70,000 pages. This added complexity has resulted in time-consuming tax forms, increased compliance costs, and incentives for businesses to move overseas. The remedy? A dramatic simplification of the tax code.
But what does simplification look like? According to Republicans, the tax returns of most Americans will fit on a postcard. This means that most of the itemized deductions will be axed in favor of a larger standard deduction. Rumor has it that the deductions for charitable contributions and mortgage interest are safe, but details are fuzzy at this point. The GOP would also reduce the number of tax brackets from seven to three, with a top rate of 33%. Republicans are hopeful that such changes will promote economic growth and global competitiveness.
At first glance, simplification is appealing, but is it realistic? A tax code that is too simple is susceptible to loopholes. Over the past 30 years, the tax code has been stuck in a loophole cycle. The steps are quite straightforward: (1) Congress passes a law; (2) taxpayers and practitioners invent schemes to avoid tax while still technically complying with the law; (3) Congress passes another law to close the loophole; and (4) the process is repeated. It’s no wonder that Federal tax law nearly tripled in length! No matter how clear and concise the tax code is, taxpayers and practitioners will always find varying interpretations of the law. Without additional legislation, the government’s interests may go unprotected.
Take, for instance, President Trump’s proposed special tax rate for flow-through entities (such as partnerships and S corporations). The intent behind this idea is quite noble—let’s put small businesses and family-run companies on a level playing field. However, this gives employees an incentive to pursue tax avoidance schemes whereby wages are recharacterized as flow-through income. Once this practice becomes abusive, additional legislation will be needed to preserve the original intent behind the law.
The quest for a simple tax code is also stalled by special interest groups. And I’m not just referring to the oil and gas industry. After President Trump and House Republicans announced their plan to eliminate the state and local tax deduction, special interest groups from high-tax states (think New York and California) began lobbying to keep the deduction. Lobbyists for nonprofit groups and the real estate industry are also on the move, campaigning against a higher standard deduction. They claim that charitable giving and home-buying could decrease if fewer people are able to claim those deductions.
The bottom line is that tax reform is a complicated jigsaw puzzle where various groups are competing to be heard. As these voices cross paths, simplicity becomes less likely. The key to reform is finding a balance between simplicity, protecting the government’s revenue stream, and appeasing special interest groups. Congress will soon find out how difficult a task this will be.
