1/31/2013 4:30 PM ET|
5 ways to fix our aging tax system
The nation's income tax, which turns 100 this year, needs a bit more than a facelift.
The idea of allowing the government to tax incomes has been controversial since the 16th Amendment was ratified on Feb. 3, 1913. Back then, the questions were much simpler: How much do people pay, and at what income levels? Do companies pay? What income sources get taxed? Where does the money go?
Those questions are still around, but the system is infinitely more complicated now. The tax code is massive, with endless deductions, loopholes, conditions, extensions, penalties and exemptions. We have to buy tax software to sort it all out, or pay tax professionals hundreds of dollars to do it for us.
The tax system is out of control. Everyone agrees with this, and that consensus transcends party affiliation or socioeconomic class. The tax system must be changed. This country has backed itself into a fiscal corner that it can't get out of without a major tax overhaul.
But how to change it is a messy thing indeed. The current Congress isn't likely to act on reforming the tax system anytime soon, because there is no political gain in doing so. Any real tax reform would be immediately controversial and challenged at all levels of government, not to mention in the courts. It would be pounced on by lobbyists and activists, and would likely be watered down or annihilated.
Few want to grab this bull by the horns. But for any willing to try, we have some ideas. Here is our birthday present to the federal income tax: five ways the system needs to change.
1. Stop taxing foreign corporate profits. The U.S. is the only major economy that taxes its companies on profits they make overseas. Executives are understandably loath to pay that 35% corporate tax rate, so companies instead park that foreign money in overseas bank accounts. EMC has stashed $5.1 billion overseas, while Google has parked $29.1 billion, The Wall Street Journal reported.
Let companies bring that cash back to the U.S. at a much lower tax rate. It would help the economy and help companies grow, and the money would actually go to good use instead of slumming in the Cayman Islands.
2. Cut tax rates across the board. A commission created by President Barack Obama has suggested (.pdf file) three tax rates -- 12%, 22% and 28% -- based on income levels. That would simplify the code dramatically. Sorry, flat-tax fans, a flat rate simply would not bring in enough revenue without crushing the lower and middle classes. But reducing the number of tax rates to three would be a big step toward transparency and fairness.
3. Abolish the alternative minimum tax. This was supposed to be a tax on wealthy people who were exploiting loopholes, but over the years it begun to punish people it was never intended to. It's a complicated layer on top of the standard tax, and about 4 million taxpayers owed this tax in 2011, Time reported.
This tax is so bad it has been modified 19 times since 1969. It's so confusing that people often didn't know if they were paying it until they were preparing their returns. That's the opposite of transparent. The tax got its latest fix in the recent fiscal cliff deal, but it should have been abolished.
4. Add a consumption tax. When you cut income tax rates and remove the alternative minimum tax, you're going to have to make up the money somehow. And that's where a consumption tax, like a European-style value-added tax, could come in handy. The U.S. is "the only leading economy without a national broad-based consumption tax such as the value-added tax," Alan Auerbach, the director of Berkeley's Burch Center for Tax Policy and Public Finance, writes in The New York Times.
Instead of a single sales tax at the point of purchase, a value-added tax implements a tax at several points in a product's supply chain. It's similar to a national sales tax but is considered easier to enforce. Liberals hate the VAT because it taxes everyone at the same rate, Harvard economist Gregory Mankiw writes in The Times. Conservatives hate it because it would provide a massive source of funding for our government, potentially allowing it to get much bigger.
5. Close loopholes. Again, if you're going to lower the tax rate, you also have to eliminate the vast number of loopholes that individuals and companies use to dodge Uncle Sam. End the deduction for interest on loans for vacation homes. Don't give fund managers ridiculous breaks on carried interest -- instead tax carried interest as regular income. Keep the mortgage interest deduction, but limit the maximum deductible mortgage to $500,000.
And don't forget about corporate loopholes. Many major corporations in this country pay little to no tax. Back in the 1950s, companies contributed 30% of the nation's tax receipts. That had fallen to 6.6% by 2009, according to The New York Times. Companies have successfully lobbied for goodies that include export subsidies, tax deferrals and favorable equipment depreciation timelines.
So happy birthday, federal income tax. Perhaps it's time to drop some of those extra pounds you've accumulated over the years. We need you in fighting shape to help pull us out of our unsustainable fiscal path.
More on retirement:
MORE ON MSN MONEY
VIDEO ON MSN MONEY
Copyright © 2013 Microsoft. All rights reserved.
Fundamental company data and historical chart data provided by Morningstar Inc. Real-time index quotes and delayed quotes supplied by Morningstar Inc. Quotes delayed by up to 15 minutes, except where indicated otherwise. Fund summary, fund performance and dividend data provided by Morningstar Inc. Analyst recommendations provided by Zacks Investment Research. StockScouter data provided by Verus Analytics. IPO data provided by Hoover's Inc. Index membership data provided by Morningstar Inc.