Millions of Americans participated this week in the annual ritual of filing income taxes-probably cursing this confusing, complicated process. While many politicians rail about the complexity of the tax system, few are actually willing to support meaningful simplification efforts. The chart above demonstrates the problem.
Current individual income tax breaks exceed $1 trillion per year. It may come as a surprise that the largest is the exclusion for employer-provided health insurance coverage. If taxed, Uncle Sam would get an extra $164 billion in annual revenue but employers might drop coverage and get out of the health insurance business for their employees. The mortgage interest deduction costs U.S. coffers $100 billion annually. But repealing that deduction would raise the cost of housing for homeowners and likely cause a further drop in home prices. Eliminating deductions for charitable donations would certainly hurt not-for-profits at a time when many are already struggling from reduced state and federal support.
Two years ago, Alan Simpson and Erskine Bowles, co-chairmen of the National Commission on Fiscal Responsibility and Reform put forward a plan to wipe the slate clean and start from scratch. They proposed eliminating all deductions, exclusions and credit and provide three tax brackets; 8%, 14% and 23%. The Simpson-Bowles proposal, which also included huge budget cuts, was finally brought to a vote in the house on March 28. It received only 38 votes. The fact is that the majority of the “tax breaks” are immensely popular and have become imbedded in our economy and society. Americans are not prepared to live without them.
Recently, Professor Michael Graetz of Columbia Law School came up with another possible solution. He would abolish the income tax for most Americans and replace the revenue with a 12.5% value-added-tax. Prof. Graetz would give each family a $100,000 tax exemption, which would eliminate income tax for 90% of those currently filing. For those with income above $100,000, top tax rates would be 20-25% on taxable income. Mr. Graetz outlined the details in his 2007 book “100 Million Unnecessary Returns.” His basic concept is that if the current tax breaks are so much a fabric of our society that their elimination is unlikely, then make them irrelevant to most Americans by instilling a large exemption and a new VAT tax.