Tax Reform: Beyond Lowering Income Tax Rates

In recent years, federal tax reform discussions have centered on comprehensivetax reform. This label does not always seem to fit though. Congressional attention is mostly focused on broadening the income tax base to lower tax rates and to move to a territorial system, at least for business income. Tax reform is a significant task, last done 30 years ago with the Tax Reform Act of 1986, P.L. 99-514. Assuming major tax reform happens only every few decades, it is important to do more than match revenue generated from the reduction of a few of the over 200 income tax preferences to reduced income tax rates. While this would improve the tax system, more work is needed to best ensure the creation of a modern and efficient tax system.

Following are suggestions for comprehensive and meaningful tax reform.

Look at all taxes: Rather than only considering income taxes, all existing taxes should be examined. Perhaps some existing taxes should be repealed for simplification and modernization. New taxes might be appropriate, such as ones that address significant negative externalities (such as greenhouse gas emissions and waste). All taxes must be considered to best ensure meeting principles of good tax policy. For example, changes to make the income tax more equitable without considering payroll taxes, which are a significant tax burden for low- and middle-income workers, limit the ability to achieve equity.

Identify and articulate the goals for tax reform: When the goals for any project are not articulated, it is challenging to identify appropriate changes or assess their effect. If the goal is simplification, more is needed than reducing the number of tax rates. The federal tax law is full of complex rules that involve numerous definitions, limitations, special rules, and special recordkeeping. If simplicity is a goal, reform will need to identify the rules and procedures that create the most complexity and simplify them. If greater equity is a goal, a discussion of the appropriate degree of progressivity and how to attain it is necessary. That discussion needs to examine the tax effect on different income quintiles of all existing tax preferences. If economic growth and competitiveness are goals, again, all tax rules that influence economic activity must be examined. For example, current tax rules favor investment in housing over most other investment. An understanding of the effect of these rules on investment and economic growth must be examined to determine whether changes in these tax preferences are needed.

Articulate U.S. strategic goals: An effective tax system should support the jurisdiction’s economic, societal, and environmental goals. Thus, it is important that these goals be articulated and at the forefront of tax reform discussions. Existing tax rules and proposals should be analyzed and evaluated to determine whether they support achievement of the goals and do not operate in opposition to the goals.

Perform a SWOT analysis: Before a business engages in a significant new plan or direction, it often first identifies the company’s strengths, weaknesses, opportunities, and threats. Applying this method to tax reform helps ensure that any new plan or strategy takes advantage of strengths and opportunities, while working to minimize the weaknesses and threats. The SWOT analysis should examine recent and emerging trends, in at least the following areas:

• Economy: For example, what types of businesses exist, and what is their size, age, and location? Data on home ownership rates, taxpayers’ debt levels, and types of income will also be useful. In addition, given the tax law’s long history of preferences for higher education, what types of post-high school learning are needed, and is the tax law suited to help attain them?
• Technology: Data on how many taxpayers use the internet and own a computer will help in improving compliance approaches. Awareness of the capabilities of emerging technology, such as cloud computing and the blockchain ledger (a public ledger of bitcoin transactions that operates without an intermediary) can help to both identify where tax rules should be updated to address today’s technology (such as the appropriate depreciable life) and identify how modern technology can be used for efficient and secure tax compliance and administration.
• Society: A review of demographic data regarding longevity, retirement age, family size and makeup, marriage and divorce rates, education attainment, work hours, telecommuting, mobility, medical needs, poverty levels, and more should help identify appropriate tax rules.
• Environment: A review of transportation, energy use, and environmental problems (such as greenhouse gas emissions) can identify where rules may be outdated or where negative externalities should possibly be addressed with a tax to discourage use (such as a tax on fossil fuels or plastic bottles). For example, the trend of more fuel-efficient and more electric cars suggests that the gasoline excise tax is out-of-date for funding highway maintenance and should be replaced or modified.

Include tax administration: While much of the difficult work of tax reform is in redefining the tax base and rates, how taxes are administered must also be reformed. The current system needs to use modern technologies and rely less on paper and mailings—and more on digital networks and powerful software. Privacy and security must be addressed throughout. Tax compliance for most taxpayers should look more like using an easy app on a smartphone rather than gathering and sorting lots of paper. Modernization of enforcement, including existing penalty and collection systems, must also be addressed. Working with state tax agencies should also be considered to benefit both the agencies and taxpayers.

Use the tax policy and reform library: Since the start of the 112th Congress in January 2011, congressional committees have held more than 80 hearings on various aspects of tax reform. (A list of hearings is available here.) In addition to this testimony, government reports, and studies from nongovernment groups, there is significant tax reform literature dating back to the Treasury Department’s Blueprints for Basic Tax Reform (1977) that provides extensive background information on the legal, economic, and administrative aspects of tax reform. Arguably, no more study is needed. It is time to organize and use the existing research in light of today’s needs and opportunities to modernize the tax system.

Included in this library are numerous reports on accountability and how to evaluate tax expenditures. This evaluation is crucial to enable our tax rules to better meet principles of good tax policy (see, e.g., the U.S. Government Accountability Office’s 2013 report, Tax Expenditures: Background and Evaluation Criteria and Questions (GAO-13-167SP), p. 2, available at www.gao.gov, in which the GAO suggests how Congress should analyze the purpose and effectiveness of tax expenditure provisions).

Comprehensive tax reform is not easy. If it were, there would be more frequent legislation after the years of discussions and debate, rather than just more discussion and debate. Among opportunities that would surface in a SWOT analysis of the federal tax system is that there is broad consensus that it is in need of reform so that it better reflects 21st century ways of living and doing business, supports the nation’s strategic goals, and reflects principles of good tax policy. A lot of work has been done in the last few decades, including by the AICPA’s members and staff. The need for reform grows more important as the tax system is weighed down by complexity, inequity, and inefficiency. Hopefully, the actions suggested above can help move the process to a productive conclusion.