This opinion piece ran in the Atlanta Journal-Constitution on Friday, April 9, 2004.
By John O. Fox
On Nov. 2, we will elect the people who will spend the taxes that many of us are paying this week. Equally important, the new representatives will help shape the future of tax policy.
God help us all.
If any candidate can explain the nation's current tax system, that office seeker should be chained up somewhere.
That's because you can't explain a 10,000-page tax code, which Paul O'Neill, President Bush's first Treasury secretary, once described as "an abomination." The laws often make such little sense that Martin Ginsburg, a distinguished professor of taxation at Georgetown Law Center, has observed, "Basic tax, as everyone knows, is the only genuinely funny subject in law school."
But Americans aren't laughing much this time of the year. Still we're notorious optimists, so let's take a more hopeful tack. Maybe, just maybe, some day we'll elect candidates who will vote to eliminate the inequities, or sheer stupidity, in the tax laws. We could begin by asking the candidates about some of these morsels:
The obstacle course on your way to the new $3,000 deduction for higher education
One of Congress' distinguishing characteristics is its capacity to move from profligacy to thriftiness in tax legislation without the slightest embarrassment. For example, it continues to tolerate an irrational tax break, in existence since 1921, that allows real estate moguls to pyramid their wealth by exchanging their real estate investments time after time without ever being taxed, even if their gains are in the billions.
Consider these simplified but illustrative steps involving Mr. Wheeler-Dealer ("W-D"): first, W-D buys land in Iowa for $100,000, and when it has appreciated to $1 million, he exchanges it for a $1 million office building in Minnesota; second, when that office building has appreciated to $10 million, he exchanges it for $10 million of unimproved land outside Atlanta; when it has appreciated to $100 million, W-D exchanges it for a $100 million office building in Chicago; and when it has appreciated to $1 billion, he exchanges it for a $1 billion office building in New York City -- and still, if his tax lawyers have planned things right, W-D hasn't paid a penny of income tax on his gain. What's more, if he then dies and bequeaths the NYC office building to Mrs. W-D, she will receive it free of estate tax; and because of another crazy income tax rule, she can sell it and still not pay any income tax on the sale.
However, when, in 2001, Congress created a teeny $3,000 deduction for higher education expenses, it required many Americans to determine their eligibility by recalculating their "adjusted gross income" under nine -- I said nine -- frighteningly complicated provisions of the tax code. Welcome to sections 86, 135, 137, 219, 221, 469, 911, 931, and, of course, 933. Section 469, for example, consists of more than four single-spaced pages with microscopic type that deal with investment losses you may have. Reading this section alone risks the onset of narcolepsy.
Hope that Grandpa dies in 2010
One of the most imaginative aspects of the 2001 tax legislation was the decision by Congress to eliminate the federal estate tax in 2010 but resurrect it in full bloom in 2011. I believe Congress did this mainly to allow the world to see how the minds of tax lawyers work. Here are two potential scenarios. Both involve Grandad. In each case, Grandad is, as we say, "very well heeled." If he dies while there's an estate tax, the family would lose a small fortune.
In the first scenario, Grandad No. 1 suffers a devastating stroke right after Christmas dinner in 2009, leaving him alive in form only. He's failing fast; he's signed one of those "living wills" that instructs the family to allow him to die under such circumstances, and the family doctor, who has been summoned, advises that he ought to be allowed to die with dignity and in peace. Fortunately, Eddie Esquire, the family lawyer, is a guest and can bring sanity to the deliberations. He quickly explains the estate tax laws. The family reluctantly agrees: Grandpa's wishes will be respected, but not until 12:01 a.m. on Jan. 1, 2010.
In the second scenario, Grandpa No. 2, in robust health but nearing the age of 90, is surrounded on Christmas Day 2010 by his 18 children, grandchildren and greatgrandchildren. All love him dearly. But Grandpa's oldest son, Rudolpho, was fly-fishing recently with Eddie Esquire, also their family lawyer, who explained the dramatic difference if Grandpa dies in 2010 rather than in a later year. Rudolpho has asked Eddie, a Christmas guest, to speak for the family.
Eddie begins by asking each member to give Grandpa their loving wishes to assure him that what he is about to hear should not be taken personally. Eddie then rises to explain to Grandpa No. 2, in the most sensitive way, the dilemma. "Is it just possible, given the pluses and minuses of the choice, that you might consider that, before Jan. 1. . ."
May it be said that this will be one of the most difficult moments in Eddie's long professional career.
Solving a problem by having you file two tax returns annually
Years ago, Congress became concerned that higher-income taxpayers were benefiting excessively from tax breaks. The simplest, most straightforward approach would have been to curtail the tax breaks.
Congress knew at the time that preparing one return was becoming extremely complicated, time-consuming and expensive. Yet, after some reflection, it gave birth to the Alternative Minimum Tax, which is determined by a second return they must file every year. They must then pay the higher of the two taxes.
Since then, Congress actually has added many more tax breaks, which may or may not be fully enjoyed by higher-income taxpayers depending on how their first return compares with the second. In the meantime, because of inflation and some income growth, more and more taxpayers who do not have very high incomes are required to file the second return -- at some cost and with some degree of irritation -- because they don't think of themselves as wealthy and don't understand why they can't benefit from all the tax breaks.
But if Congress now eliminated the Alternative Minimum Tax, it would lose a lot of revenue.
Yes, with 20-20 hindsight, maybe the public would have been served best if Congress had the guts to eliminate the obvious excesses of the tax breaks in the first place. But depriving higher-income people of tax breaks in such a transparent way might have made it more difficult to be re-elected.
IRS in name only
Less than 1 percent of all income tax returns are audited because Congress lacks the resources to audit more. Congress' refusal to appropriate more money for the Internal Revenue Service also has meant that it fails to collect each year over $300 billion of taxes it knows is owed -- about the amount of interest the government will pay this year on our nation's total debt.
Two years ago, Charles Rossotti, then commissioner of the IRS, a Republican appointee of President Bush, recommended hiring 30,000 more auditors, collectors and other tax law enforcers, in order to catch the tax cheats and collect the taxes they owed.
But it was a foolish request, threatening to burden the government with an additional cost of perhaps $200 million annually. (Note: This would be far less than 1 percent of $300 billion.)
The despicable single taxpayer
I would like to think that Congress actually is unaware of how shabbily it treats most single people for tax purposes. Otherwise, we have reason to conclude that Congress believes that the majority of singles -- people who are unmarried and have no dependent children -- are, well, almost un-American.
Here's proof: Congress expects all single people who claim the standard deduction, rather than itemized deductions, to begin paying tax on income that isn't even enough to lift them up to the government's poverty threshold. Last year, the poverty threshold for singles was about $9,600. Yet these non-itemizers -- who represent about 80 percent of all single taxpayers -- had to pay an income tax once their income exceeded about $9,300. Even if the figure were $9,600, it would be ridiculously low. First of all, it's not really $9,600, because they paid Social Security and Medicare taxes. This left $740 a month, surely inadequate to cover basic living expenses.
Congress obviously thinks highly of family values. It doesn't want a couple with two little kids, whose official poverty threshold is $19,000, to pay a dime of income taxes until its income reaches nearly $48,000, two and a half times the poverty threshold for a family of four. Congress thinks highly of people who vote. As a group, married people are much more likely to vote than are single people.
The healthy menu of "cafeteria plans"
Congress is admirably upfront here. It actually titled section 125 of the tax code "Cafeteria Plans," which encourages companies to offer employees a menu not of food but of tax avoidance opportunities. You simply tell your employer to reduce your wages by the amount that you want to spend on a range of personal expenses, and your employer will pay these bills for you. Everything paid in this way escapes not only the income tax but also Social Security and Medicare taxes.
So pick up your tray, get in line and start choosing among many delicious items: some health insurance premiums, some out-of-pocket medical expenses, a little disability income insurance, some life insurance, a nice portion for child care expenses, a bit for commuting and parking.
Guess which companies offer the most comprehensive cafeteria plans? The biggest ones, of course, that have the staff and sophistication to administer them. These companies also, on average, pay much higher wages than do small businesses. All of which increases the likelihood that our tax burdens may depend more on our ability to avoid taxes than on our ability to pay them. Why not ask candidates if they think that's fair.
The size of your child care subsidies depends on which code section applies
Congress offers working parents with young children a tax credit for their child care expenses while at work. Each $1 of credit reduces their taxes by $1. The maximum credit is $1,050 for one child and $2,100 for two or more children. To make sure, however, that lower-income parents, who need the subsidy most, receive the largest credit, Congress reduces the credit as parents' income moves to higher ranges. Consequently, higher-income parents may save no more than $600 in taxes for the child care expenses of one child or $1,200 in the case of two or more children.
Another statute, however, allows all workers to exclude from their income up to $5,000 for child care expenses even if the entire amount is for a single child, as long as the payment is made through a cafeteria plan. A $5,000 exclusion will save $1,750 for an executive who is in the 35 percent marginal tax bracket and pays child care expenses for his son.
Haven't we been taught that consistency is the hobgoblin of small minds? Furthermore, you can't expect Congress to keep all those code sections in mind. Who can? Let's ask the candidates.
A choice between the family home and the family business
Would Congress rather that you invest your money in your principal home or in a family business? According to the tax laws, you must choose your home. For example, if your son and daughter-in-law, Chris and Elsa, buy a $2 million home, live in it for 2 years and then sell it for a $500,000 gain, Congress exempts them from tax on their entire gain.
What's more, they can benefit from the exemption an indefinite number of times, every two years. In fact, if either Chris or Elsa is a home builder, their strategy is clear: build expensive home No. 1; live in it for two years while they're building an even more expensive home No. 2; then sell No. 1 for a gain and move into No. 2, and start building an even more expensive home No. 3; and on and on and on. At no time will they pay any tax on their gain as long as the gain doesn't exceed $500,000. (People who don't file joint tax returns get to play the same game, but they can exempt only $250,000 from tax on each sale.)
No such exemption exists for any other investment, including the family business. So if Chris' parents, Peter and Susan, invest their money and labor in a family business for 35 years, and finally sell it for a $500,000 gain when they retire, they have to pay full tax on the gain.
Bringing you and your brother closer together
Congress prefers that you live in a state that depends upon an income tax rather than a sales tax. Here's why: Before the Tax Reform Act of 1986, people who itemized their deductions could deduct state and local income taxes and sales taxes. Since then, state and local sales taxes cannot be deducted. So if you have exactly the same income and family size as your brother who lives just across the state line, but your state depends upon a sales tax, and your brother's state depends upon an income tax, you would pay higher taxes.
I guess that makes sense. There must be something wrong about living in states that depend on sales taxes. So accept it. And do what Congress is signaling for you to do. Move to the neighboring state. You can live even closer to your brother. What's more, you probably can deduct your moving expenses.
John O. Fox, author most recently of 10 Tax Questions the Candidates Don't Want You to Ask, is a retired Washington tax attorney who teaches a course on U.S. tax policy at Mount Holyoke College called Winners and Losers.