(Photo via the Treasury Flickr feed)
Policymakers in Washington have adopted a fundamentally Keynesian response to the Great Recession, but not all economists agree with the administration’s strategies for economic growth. In fact, many economists are more interested in addressing long-term economic problems that confound entrepreneurs and make business investment challenging. The best place to start may be the ossified federal tax code: roughly 74,000 pages of code, IRS rulings, and regulations fashioned together by high-powered lawyers and lobbyists who prefer to ply their trade in the halls of Congress, safe from market forces and the gales of creative destruction.
According to the federal government’s latest Information Collection Budget, the public spent more than 9 billion hours responding to federal paperwork requirements. That’s more than 380,000 days that could have been used to do something more productive. And roughly 75 percent of this paperwork burden derives from the federal tax code. Indeed, instructions included with the standard tax return suggest it takes 16 hours and $270 to complete the typical 1040 form.
The ideal tax code should collect the revenue needed to fund the required functions of government in an efficient and transparent manner. Unfortunately, the U.S. federal tax code has become one of the most complicated tax systems in the world, and its workings are anything but transparent. The tax code has become a tool for social engineering and economic planning that doles out revenue to favored interest groups and political constituents. One study by the Tax Foundation noted that loopholes carved out of the tax code total over $1 trillion—7 percent of GDP.
Because of its complexities, the tax code exacerbates poorly crafted public policies. The wind production tax credit, for example, has encouraged billions in investments in technologies that have yet to be proved viable on their own. And the sacrosanct mortgage interest tax deduction surely played a role in the housing frenzy leading up to the 2008 collapse. Even worse, the tax code treats individuals differently based not on their income, but on how that income is used.
For example, renters with no mortgage interest deduction shouldered the burden of bailing out banks equally with those speculating in the housing market. In a sense, the tax code penalized the prudent behavior of renters while those flipping houses were enjoying a healthy subsidy through the tax code.
Not only is the current tax code distortionary, but it relies on a static and unmoving vision of the economy that is poorly designed to deal with innovation and technological advance. Consider the Marketplace Fairness Act, which was introduced to impose new taxes on e-commerce in an attempt to assuage brick and mortar retailers. Despite the fact that internet retailers see none of the benefits of those taxes, such as police and fire services that brick and mortar retailers enjoy, lobbyists are gathering in Washington for the latest assault on the tax code. Such debates play out every year, because the tax code has become a tool for policy rather than a means to fund the government.
All these discrepancies suggest that the tax code should be revisited. Political interests have modified and distorted the code to the point where even tax professionals have difficulties have difficulties understanding it. The American public, consumers and businesses alike, would be better served by a broader-based, flat tax that is simple, fair, and honest. Investments would be driven by entrepreneurship, not politics, and both new and old technologies would be on equal footing, with no need to petition Congress for special tax treatment.
As Adam Smith put is so simply in 1776, “Every tax ought to be so contrived as both to take out and keep out of the pockets of the people as little as possible, over and above what it brings into the public treasury.” The tax code should be simple and easily understood by taxpayers trying to calculate their tax burden. In addition, it should be efficient, collecting the required revenues in a manner that imposes the least cost on individual taxpayers. The tax code should be fair, applying the same principles to all taxpayers. And above all, taxes should be low, allowing taxpayers to keep hard-earned dollars rather than send them to Washington. On all these accounts, the current system is a failure. There has been plenty of talk recently about loopholes and crony capitalism; perhaps it’s time to cut to the heart of the issue with an overhaul of the tax system.