Policy
Simplifying the tax code introduces new complexities.
The complexity of the U.S. tax code, with its maze of deductions, exemptions, and different rates, imposes significant costs and burdens on households and businesses every year in the form of time spent preparing returns and money paid to tax preparers. A report by the nonpartisan Tax Foundation found that in 2016 Americans spent almost 9 billion hours complying with IRS tax filing requirements.
In addition, such complexity may distort economic decisions, making our economy less efficient. For example, if individuals do not know their marginal tax rates—there are currently seven brackets—they may make saving and spending decisions based on an incorrect amount of take-home pay.
It is not surprising, then, that politicians have long promised to simplify or reform the tax code.
These promises, along with tax cuts, were echoed this year both by President-elect Donald Trump and Republican congressional candidates. So with the GOP now controlling Congress and the White House, it might appear that major tax code reform is on the horizon. However, the president-elect and House Republicans have put forward very different plans. While Trump has promised to simplify the code, his proposed plan does little of the sort. The House GOP’s “Better Way for Tax Reform” plan actually takes steps to simplify, however. Democrats, who control 45 seats in the new Senate (above the threshold of 40 needed to sustain a filibuster) may have some leverage here in helping tip the scales between either plan.
How the Republican plans compare
The greatest area of overlap between the two Republican plans is in tax brackets. Both propose reducing the number of brackets from the current seven, which range from 10 percent to 39.6 percent, to three—12 percent, 25 percent, and 33 percent. However, this is the only area where the Trump tax plan actually simplifies anything.
The two plans disagree markedly on tax deductions, which are generally considered the greatest source of complexity in the tax code. The GOP plan would eliminate almost all deductions other than for home mortgages and charitable contributions, while folding everything else into a new larger standard deduction ($12,000 for individuals, $18,000 for individuals with a child, and $24,000 for married couples). The Trump plan would consolidate personal exemptions into an even larger standard deduction ($15,000 for individuals and $30,000 for married couples). But it would not eliminate the deductions targeted for cuts by the House GOP, and it would add new deductions for dependents (both children and elderly), leaving the current system largely intact.
The trade-off in any tax simplification is that the tax code is one of government officials’ most effective tools to subsidize or discourage certain behaviors. The GOP plan retains a child credit, an earned-income credit, and a higher-education credit, but it boils down what is currently a wide range of credits and exemptions to one simple calculation in each category. The Trump plan retains more itemized deductions and offers a new rebate on child-care expenses as part of the earned- income tax credit. It proposes, for those with children and certain income levels, dependent-care savings accounts that are eligible for government matching. The Trump plan retains much of the current capital-gains tax structure (but under its proposed new tax brackets), while the GOP plan proposes effectively exempting half of investment income but treating the other half as ordinary income. The Trump plan retains more precision and flexibility in setting tax rates, but the GOP plan is more streamlined and may be easier for households to understand.
Higher education tax policies could be simplified
One area where tax simplification could have significant benefits is in higher education. In a March 2016 working paper for the National Bureau of Economic Research, Susan Dynarski and Judith Scott-Clayton reviewed the impact and structure of tax benefits for higher education (www.nber.org/papers/w22127). The current tax system subsidizes college expenses throughout a student’s lifetime, with benefits for college savings programs, deductions for tuition costs, income exclusions of scholarships or tuition reductions, and deductions for interest on student loans. Possibly because of the complexity and dispersion of these benefits, empirical analyses have found little impact of these tax benefits on educational achievement. A consolidation of these many programs into one simple and transparent credit could simultaneously affect students’ behavior and drastically reduce administrative costs.
The nonpartisan Tax Policy Center writes that the GOP plan “would boost incentives to work, save, and invest if interest rates do not change.” The plan would substantially reduce federal revenue, and it cannot be thoroughly evaluated without seeing what cuts in spending and the federal deficit would be made concurrently. But the TPC’s analysis is a sign that that the tax code could be significantly streamlined without adversely affecting taxpayer incentives. This is a worthy goal given the billions of tax-return preparation hours that could be saved with even a modest reduction in tax complexity.
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