Overhauling IRS code a taxing proposition

Author: Pamela Yip

Published: November 8, 2004

Now comes the hard part.

President Bush has sketched a second-term agenda that includes tax overhaul. But what he has to do to get there is another story.

"We must reform our complicated and outdated tax code," Mr. Bush said last week. "We need to get rid of the needless paperwork that is a drag on our economy."

The Internal Revenue Code is enormously complex, convoluted and the product of often-inept tinkering by Congress.

But the rub is that as much as we complain about the tax laws, every provision that adds to the complexity also is someone else's treasure.

"Almost every provision benefits someone somehow," said Mark Luscombe, principal tax analyst at CCH Inc., which publishes information for tax professionals. "If it's truly simplified, then some of the people who had benefited from the current code may not feel that they are adequately benefited by the simplified structure."

One way to simplify the tax code is to go with a flat tax.

"If you really want to simplify the code, you want to go with a flat tax on all income, with no deductions," said Wayne Shaw, an accounting professor at Southern Methodist University and a former IRS agent. "The dilemma is: How do I tax people who own their own businesses, because they don't have something equivalent to a salary?"

Mr. Bush has made it clear that he wants small business to be a key beneficiary of his tax-overhaul efforts.

"This is an administration that fully understands that the job creators are the entrepreneurs," he said. "And so in a new term, we will make sure the tax relief continues to be robust for our small businesses."

A flat tax would raise another issue.

"You're proposing one marginal rate," Mr. Luscombe said. "People at the very high end of the current marginal rate structure might benefit from one marginal rate, because their marginal rate might be reduced. People at the lower end may or may not benefit."

The flat tax rate probably would be a higher rate than what low-income people currently are paying.

"So the question is, would there be one exemption to protect them," Mr. Luscombe said. In other words, if your income didn't exceed a certain amount, you might not have to pay any tax.

Studying options

Mr. Bush is expected to create a commission to study tax overhaul options and push the panel's recommendations through Congress.

It will help that the president will be working with a Republican-controlled Congress.

"With a more Republican Senate and House, one of Bush's first priorities will be to make the tax cuts permanent so that the Democrats don't get a chance to unwind them with a presidential victory in 2008," said Jeremy Siegel, finance professor at the Wharton School at the University of Pennsylvania.

Mr. Bush also has a head start on using the tax system to encourage people to save more and take more responsibility for their financial future.

He's expected to reintroduce a package of tax-advantaged savings accounts that he presented last year, and he's also called for tax breaks to encourage consumers to open health savings accounts.

"He's signaled in a number of ways that he'd like to move the tax system away from a tax on income to a tax on consumption and spending," said Leonard Burman, co-director of the Tax Policy Center, a nonpartisan joint venture of the Urban Institute and Brookings Institution. "The challenge that he faces is if he were to change from an income tax to a consumption tax without cutting taxes overall, he almost inevitably would have to raise taxes on a lot of middle- and lower-income people."

Caution needed

No matter what your political persuasion, there's no argument that the tax code is in desperate need of change.

"All these special tax breaks for every kind of thing you can imagine - they create choices so complicated that you almost have to have a Ph.D. to figure out which education tax break makes the most sense," Mr. Burman said.

But in trying to simplify the nation's tax laws, Congress needs to be careful it doesn't end up chasing its own tail.

"Over time, Congress has made provisions to close loopholes or to try to do some social engineering, and a lot of the provisions are very difficult to comply with and require extensive regulation from the IRS to try to interpret them," Mr. Luscombe said. "Now we have an ever-growing tax code that's difficult to comprehend.

"The risk in simplifying things is you just start the process all over again," he said. "The complexity will start creeping back into the system again."