Hey! Guess what I got in the mail this past week - my 1040 Form! Yea!

1998 is an election year, and as always taxes will be on the agenda of people running for office as well as on the minds of the electorate. One of the most common components contained in most fundamental tax reform proposals is a promise to "simplify" the tax system. Filling out your tax forms can be a pain in the rear and it certainly would be nice to have only a postcard sized tax form to fill out. In Denmark, most people get sent a statement of their tax account which they only have to sign and return - nothing to fill out or calculate.

So, what is it that makes income taxes complicated? Contrary to many of the recent claims by tax reformers, multiple rates do not complicate things in the current system. The "flat tax" - by which I mean creating only one tax bracket - does not by itself simplify anything: only the table which you use to look up your tax would change.

The real effort in filing out your tax form comes from two primary sources: 1) dealing with tax rates that differ by source of income, and 2) dealing with various deductions and exemptions.  To substantially simplify tax returns, we must remove the individuality from tax determination. I have one suggestion to add to the list below.

Individuality

In short, the reason that the tax forms you fill out are complicated is that the IRS needs a good deal of information in order to calculate exactly how much tax you owe.

For example, on the 1997-1040 form you have to list income from wages, interest, dividends, capital gains, alimony, business income, IRA distributions, pensions, rental real estate, farm income, unemployment compensation, social security benefits, and, of course, "other".

On the deductions and credit side you have to list deductions related to IRAs, Medical savings accounts, moving expenses, self employment, health insurance, Keogh plans, alimony paid, early withdrawal of savings, and of course you might have to itemize your deductions for charitable giving or mortgage interest.

To substantially simplify anything, we need to get rid of the preferential treatment of different type of income and the variety of deductions - in short, we need to remove individuality from tax forms.

Proposal for Simplifying the Charity Component

Removing the need to itemize charitable deductions would go a long way in simplifying the tax code. One way to do this is to simply remove the deductibility of charitable giving. "Wait, Wait!" I hear you yelling "Giving is something that should be encouraged!"

Ah-ha! There is a way, however, to keep the current preferential treatment of charitable giving without mucking up tax forms. Rather than giving you a tax deduction, the federal government could instead match the funds as they are contributed to the non-profit organization. The matching rate would give the same amount of preference as the tax deduction. See the table below for an example.
 

Conclusion

You will undoubtedly hear quite a bit in this next election season about simplifying the tax system. It will be important to keep in mind what makes the system complex and to make sure that the proposed simplifications match the present complexities.

The calls that will be made for a flat tax must be evaluated in this light. If the proponents only talk about creating a single rate - and do not address the various deductions and income source differences - they are not talking about simplifying your tax return. The reason for the omission is obvious - people like their deductions - and talking about simplification in the abstract is politically much easier than talking about removing beloved deductions.

And, as a service to all of my kind and generous readers, my proposal for charitable deductions would ease the pain associated with itemized deductions.

See Also:

• 1040 Forms can be downloaded from the IRS.
• Federal Tax Reform: A Family Perspective (Tax Reform) from the Urban Institute.
• IC Opinions 8/21/97: Glassman: Tax Law Disaster: A "Nightmare Come True" on the complexities of the current law.
• If you are interested in reading more about tax reform I recommend reading Taxing Ourselves: A Citizen's Guide to Great Debate Over Tax Reform by Joel Slemrod and Jon Bakija for a nice user-friendly introduction.

What is it that makes income taxes complicated? | Posted January 13, 1998 03:12 PM by John Irons