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In the Nation's Interest

“Tax Simplification:” A Misdirection Play in Four Acts

The first piece of advice offered to would-be influencers of the tax legislative process most often is, “Whatever you want to do, call it 'reform.'” The second probably would be, “Once you clearly have over-used the word 'reform,' call it 'simplification.'” In other words, “tax reform” in practical usage has long ago lost its meaning. It is a mind-dulling drug that is intended to conceal the fact that the listener is about to be jobbed. “Tax simplification” is just one short step behind in its anesthetic effect.

What is going on today is – arguably – a misdirection play. Look, there’s some simplification – while behind you, the tax law is being made more complex to a totally different purpose.

Act one in today’s farce: Have you heard that the tax law is about to be “simplified” by reducing the number of tax brackets? It sounds so self-evident. But ask yourself: Did you know how many tax brackets there are in the current law (before this argument was recently put forward)? What percentage of the tax filing population do you think knew, and what percentage know what a “marginal tax rate” is? And of those, how many can tell you accurately what their own marginal tax rate is? I would wager that the number would be barely enough for a decent duplicate bridge tournament.

Truth be told, the vast majority of taxpayers can do a perfectly decent job of filling out their own tax returns without ever knowing what a tax bracket is, or which bracket they are in. This is true whether the taxpayer uses tax software, or pen and paper. The IRS gives the pen-and-paper taxpayer a lookup table that makes no reference to tax brackets, and requires no arithmetic. In fact, if you asked the typical taxpayer whether it would be a good thing to reduce the number of tax brackets, you would probably get a “yes” – because, you would be told, you get hit with a big tax increase when you rise from one bracket to the next – which is, of course, not true.

Act two: You have heard that the new tax law will eliminate the personal exemptions to “simplify” the system. Ask yourself: How complex is it to know how many people there are in your family? And the IRS gives you another lookup table, so that you don’t even need to multiply the amount of the exemption times the number of family members. (And of course, if the taxpayer uses tax software, even these simple steps are unnecessary.)

Act three: The new law is designed to reduce the number of people who itemize their deductions. That’s big simplification, right? Well, for most taxpayers, itemizing deductions means mortgage interest and property taxes. Your mortgage lender hands you those two numbers; you simply transfer those numbers from the mortgage form to your Form 1040 Schedule A. Tax software does this for you. It’s a little harder with paper, but the calculation still comes down to that final, simple lookup table to find your tax.

Truth be told, the complexity in the tax system simply isn’t in the tax form. It’s just not. The complexity comes when the tax system offers you tax savings if you build tax considerations into your daily economic life. That is when some taxpayers start sweating bullets over tax complexity.

Want to make the tax system even more complicated? Here’s a way – Act four: Offer “pass-through” businesses a lower tax rate than applies to plain-vanilla wage and salary or interest income. People in high tax brackets will collaborate with their accountants and attorneys to recharacterize their earned or investment income into “pass-through” form. Look for Personal Services Corporation, LLC to offer the skills of NFL, MLB, NBA and NHL stars (and many more highly compensated workers) to their teams or other employers. Watch people of enormous wealth create their own LLC investment companies – and then parse out their dividends and capital gains between the LLC and the preferential tax rate already in the law, whichever is less. Talk about complexity! The advocates of this “framework” assure us that they will restrict the pass-through preference to “real” businesses. No tax expert I know believes that is possible. And what is a “real” business? Whatever is written in the law, the real answer will be defined by Attorneys and Accountants, LLC, working by the billable hour.

This isn’t simplification. And it isn’t reform, either. It is so frustrating to watch the tax law being butchered, and the budget deficit being inflated, both in the name of “reform” and “simplification.” At the end of the day, ostensible “simplifications” are being used to pursue totally different and unstated ends.

We did this right once, back in 1986. And today, nobody asks, and nobody cares. If the current misdirection play makes it to the final curtain, five years from now the audience will be asking itself, “What were we thinking?”