History suggests a U.S. tax overhaul is coming soon, says T.R. Reid of The Washington Post.
For all the controversy U.S. President Donald Trump can stir up, there is one thing he wants to accomplish that many people favor: cleaning up the complex — and many would argue, unfair — U.S. tax system. That doesn’t mean the task will be easy, of course. While most of us hate the system we have, we don’t agree about what we’d like to replace it with. Further, for every loophole, deduction or benefit, there’s a constituency (with lobbyists) that will fight to the bitter end to protect it. Even its annoying complexity has powerful defenders. It’s a monster — and its size makes it hard to kill.
You may therefore be happy to learn that even though they are a political nightmare to pull off, U.S. tax overhauls have happened on a schedule — like clockwork, and the timer happens to go off again next year. Given that history and necessity are about to collide, Washington Post reporter T.R. Reid got curious about what tried-and-true solutions America could implement to make that next version of our tax system better. To find out, he traveled the world see what has worked best elsewhere, and brought those ideas home in his new book, A Fine Mess: A Global Quest for a Simpler, Fairer and More Efficient Tax System. He joined the Knowledge@Wharton Show on SiriusXM channel 111 to talk about what he learned.
An edited transcript of the conversation follows.
Knowledge@Wharton: What are some of the things that other nations are doing with their tax codes that we’re not?
T.R. Reid: Our system is unique in the world, and it’s crazy. It’s 73,000 pages. I asked the Commissioner of Internal Revenue if anybody at the IRS has read the whole thing. He laughed. He laughed at the very idea. It turns out that other countries have done what our Congress can’t seem to do, and that is made it simpler. Americans spend 6 billion hours gathering the records and filling out forms. We pay tax preparers $10 billion a year. An average family at the median income — about $56,000 — spends 12-1/2 hours just doing their taxes, and they spend about $260 getting somebody to do it, on average. Guess what? In other democracies, it takes 15 minutes and $0 to pay your taxes. We could do that, too.
Knowledge@Wharton: You bring up an interesting point in your book, that about every 32 years, the tax code gets so massive, so expansive, that it has to be pared down. And we’re coming up on that point in the cycle. But to pare down that code seems like a massive undertaking, and a very hard thing to do.
Reid: It’s hard to do, but it has to be done. I think it’s going to happen because nobody defends our current tax code. Republicans, Democrats and the president all say we have to fix it. We’ve seen this pattern in history. The federal income tax started in 1913, and it was a very popular tax then. We hate it today, but at that time, it only taxed the Rockefellers and the Vanderbilts, so people really liked it.
In 1922, Congress wrote a comprehensive tax code. Over the next 30 years, lobbyists and accountants came in and added all sorts of exemptions and credits and loopholes. The thing was a total mess. In 1954, it was such a mess that they threw it out and started over. That’s the Internal Revenue Code of 1954. Guess what? Thirty years later, it was a mess. They threw it out and started over. That’s the Internal Revenue Code of 1986. The pattern there is every 32 years we have to do this, and the 32 years is up in 2018. And guess what? Our code is a monster. Nobody can defend it. History repeats itself. The time has come to throw it out, get rid of all the loopholes, lower the rates and start over. I think we’re going to do it.
“It’s as if in taxation, as Americans, we’re still banging out letters on a typewriter and dropping them in the mailbox, and everybody else is texting and using Instagram.”
Knowledge@Wharton: What are some of the loopholes you think could be fairly easily removed from the system?
Reid: Well, at the moment, there are hundreds of them for specific corporations, that give a credit to one corporation. But for individuals, we give tax breaks for taking a night school course, growing sugar cane, replanting a forest, insulating the attic, paying off a mortgage, destroying old farm equipment, employing Native Americans, commuting to work by bicycle — but only specific bicycles. Here’s one I really like: What if the president went to Congress and said, “Why don’t we send a check for $7,500 to any American who buys a $138,000 BMW hybrid?”
You know, we’d never pass that. Give a tax break to rich people for buying a German car? But we did it. It’s in the tax code. The tax code is just laden with hundreds of these giveaways. Most people don’t even know they’re in there, and they cost $1 trillion a year in lost revenue. That’s money we could use to treat veterans or reduce the deficit.
Knowledge@Wharton: Some countries have it so simple that it only takes people a few minutes to file their taxes. The Dutch, about 15 minutes, on average. Britain and Japan, five minutes. A lot of what makes that possible, I’m guessing, is they don’t have a lot of these extras in their tax code. But I would think that probably for a majority of citizens in those countries, their taxes are already factored in based on their regular pay, and they don’t have to worry about them ever again. These countries have it set up so it’s a non-issue.
Reid: Yes, that’s right. I was in the Netherlands last year on March 31. Their Tax Day is April 1. I was with a guy, an executive. He makes about $200,000 a year, and I said, “Michael, how do you pay your taxes?” Well, here’s what he does. He pops a beer, he goes online, and he looks at the form. And the IRS in the Netherlands, they know all the numbers.
So they’ve already filled in the form for him. If it looks good, he just clicks “OK.” It takes two minutes. But he says to me, “You know, I don’t trust government that much, so I like to check the numbers they’ve filled in.” And now he’s getting mad. He says, “You know, you start checking the numbers, it can take almost half an hour just to pay your taxes! What an outrage!”
In Japan, the government sends you a postcard. It says, “We think you earned this much. We withheld this much. We owe you a refund. We’ll put it in your bank account on April 1,” and if the numbers look right, you do nothing; 85% of the people in Japan don’t have to file a tax return because the government has the numbers and does the work for you. And in America, the IRS knows all the numbers for almost every family.
They have this form. They send out millions of copies every year of this form — it’s called a CP2000 letter. That’s the one that says things like: “On line 47-A, you entered $4,211. It should have been $4,654.” I get that every year, and I think, “Well, if they already knew, why did I spend hours filling out a form to tell them the number they already know?” We could do this, too. In other countries, the government does the work for you, and you just check it. And guess what? When this was proposed in Congress, H&R Block lobbied against it.
Knowledge@Wharton: As the process stands here in the United States, you have so many people who have a financial interest in having the tax system stay the way that it is — very convoluted, and tough for the consumer. And unfortunately, given the way that Washington works, it’s hard to imagine that the lobbyists for those interests aren’t going to have a very important role in how any changes to the tax code in the next few years play out.
Reid: Yes, they’re of course going to try to add the exemption for their particular client. The answer to that — and we’ve seen other countries do this — is you have to say to them, “Look, if we give you this tax credit, we’re going to have to raise rates for everybody.” So there’s a political tradeoff. You get rid of exemptions that companies and people like, but you have a simpler form, and you get much lower rates. That tradeoff has worked in many countries, and it worked in the United States in 1986. That’s what we did. We got rid of all sorts of giveaways and credits, and sharply lowered the top rate. In the 1980s, it went from 70% to 28%, with no loss of revenue. So my argument is other countries have done it. We’ve done it. We could do it again. But you have to stand up to these lobbyists.
Knowledge@Wharton: How do they deal with the problem of identity theft in a lot of these countries? That continues to be a problem, especially around tax time, here in the U.S.
Reid: That’s a growing problem for everybody. What happens is people take your Social Security number, and file and try to get a refund in your name. Then, when it’s time for you to get the refund, the IRS says, “We already paid that.” This is a problem in every country. And every country is struggling with it. But again, when the system is simpler — where the government’s tax agency fills out the form for you — then you don’t have this problem of people filling out a phony form in your name.
Everybody’s struggling with this. Nobody has solved it completely. But the method that other countries have used, where the government does the work for you and fills out the form — that sharply cuts back on this identity theft problem.
“In Japan, the government sends you a postcard. It says, ‘We think you earned this much. We withheld this much. We owe you a refund. We’ll put it in your bank account on April 1.’”
Knowledge@Wharton: You talk about the importance of the value-added tax in a lot of countries, and how, to a degree, the U.S. has missed the boat on this.
Reid: The VAT is a sales tax that applies at every level of commerce, wholesale or retail. It was invented in France in the 1950s, and economists like it because it taxes consumption. It doesn’t tax labor or savings. Governments like it because it’s a really hard tax to duck. Everybody ends up paying it, because you can’t get out of it.
And people like it because you use the revenue from the value-added tax to lower the rates on the corporate or personal income tax. It’s very popular. It works. It’s an efficient tax, and therefore 176 countries have it. The only big country that has missed out on this really good idea is the United States. So I say in my book, you know, it’s as if in taxation, as Americans, we’re still banging out letters on a typewriter and dropping them in the mailbox, and everybody else is texting and using Instagram. We’ve really missed out here.
It’s such a good idea. Eric Zolt is a professor at UCLA Law School, and he has designed tax codes for about 40 countries. He told me it would be malpractice not to include a value-added tax in any system. He said, “you know, the VAT is such a good idea, even the U.S. Congress will figure it out. Mark my words: Within five years, the U.S. will have a VAT.” And then he said to me, “Of course, I’ve been saying that for 20 years.”
Knowledge@Wharton: I was going to say, with some of the people in Washington, D.C., right now, that five years might end up being 20 or 30.
Reid: Exactly. I think the time is now. I think Congress is ready. The president has promised it. People are demanding it. And you know, my book shows it can be done. Other countries have done it. We could do it, too.
Knowledge@Wharton: There’s also the concern about all these other taxes that are being added at the local and state levels. For example, here in Philadelphia, the soda tax, which is designed to try and help fund pre-K education.
Reid: I think that’s right. But on the other hand, Philadelphia didn’t do it right, let me just say. The notion of a soda pop tax: If you tax sugared soda, it fights obesity, it fights tooth decay, two problems that are expensive for the public at large. If people are going to drink a lot of sugared pop and have a problem with obesity and diabetes as a result, well, we ought to ask them to pay more to offset the social costs. Philadelphia, of course, put the tax on diet pop, too, which to me doesn’t make sense. But a lot of countries, and now several cities in the U.S., have put this tax on, and what we see is when they do it right — unlike Philadelphia — there is a dramatic shift to diet soda or just to bottled water. Over time, that’s going to reduce obesity and reduce tooth decay and save the whole society money.
Knowledge@Wharton: Is the key to the U.S. system, then, being more innovative and bringing more of this process online?
Reid: That’s exactly right – and it’s what other countries have done. I went to the World Bank when I started this book, to see what makes a good tax code. The economists there — they advise countries all over the world, and they told me the formula. The formula is “B.B.L.R.: Broaden the Base, Lower the Rates.” Broaden the base means you make everything taxable. If your employer pays your health insurance premium — well, otherwise, that would cost you money. So it’s like income to you. Let’s tax it.
Then you get rid of all the exemptions and giveaways. If you do that, you get much lower rates. So that’s the solution: Adopt the B.B.L.R. model. Many countries have done it, with good results, as I show in my book. And the U.S. did it in 1986.
Knowledge@Wharton: Part of this, also, would be changing the type of benefits our leaders in Washington, D.C., can get through the tax system — seemingly, they get pretty healthy ones.
“What I’ve found in other countries is you have to do tax reform big. You can’t just do one piece of it.”
Reid: Yes, members of Congress have given themselves tax breaks that nobody else gets. They get special tax rates for having a second home in Washington. They get tax breaks for their travel. Nobody else gets these. I think that’s wrong. One of the things I really liked when I went around the world: In Slovakia, they have the opposite rule. In Slovakia, their rule is that members of the parliament or the cabinet have to pay 5% higher rates than anybody else at their income level in the country. In other words, if you write the tax law, you pay more. And that makes people think twice before changing the tax law, because they’re going to pay more for it.
Knowledge@Wharton: Could we potentially do a flat tax rate here in the U.S.?
Reid: Well, many people, Republicans generally, propose the flat-rate tax. In 2016, six of the Republican candidates proposed a flat-rate tax, although Donald Trump did not. And when I went around the world, I found that 12 countries have tried this. We have graduated rates, going from 7% to 39%; most countries do. But 12 countries in Eastern Europe tried this: Everybody pays at 18%. What I found, and I say in my book, is: If you’re a former Soviet republic, where everybody makes about the same low wage, and there’s no investment capital, then the flat-tax rate works. It did bring in investors from Scandinavia and Germany and beefed up investment in those countries.
It works for five or six years, and then what happened is when they hit the economic downturn in 2008, the flat-rate tax just didn’t bring in enough money. You just can’t set the rate high enough to bring in the revenue you need, but low enough for average families to pay. And so most of them have given up on it. A couple of them have kept the flat rate, and therefore, they have to raise other taxes to make up for the lost revenue. Like Hungary has a flat-rate income tax of 15%, and to make up for what they lost, they have the world’s highest sales tax: 27% tax on everything you buy…. It would not work in the United States.
Knowledge@Wharton: You also mentioned the famous U.S. mortgage interest deduction, which a lot of countries don’t have, and that despite that, the data you collected show higher home-ownership rates in other countries than the U.S.
Reid: That deduction costs the Treasury about $103 billion a year — money we could use to treat wounded veterans, or reduce the deficit, or build a stronger border, if you want to do that. And instead, we give it as a subsidy. And only the richest one-third of homeowners take that deduction, because others use the standard deduction. Most rich countries have gotten rid of the mortgage interest deduction. And guess what? As you say, home ownership rates stay exactly the same. Britain got rid of it. They have a higher rate of home ownership than we do. So it really doesn’t achieve its purpose of enhancing home ownership, and it costs a lot of money that we could use for other stuff.
Knowledge@Wharton: At some point in the next year, year-and-a-half, this is going to be on the floor of the Congress. What do you expect that we will see?
Reid: I think we’re going to lower the corporate income tax rate; it’s not fair to American corporations. But if that’s all they do, then that’s not a good idea, because it’ll just reduce revenue. They have to do a comprehensive plan where you get rid of all the credits and exemptions and loopholes, and then you can lower rates for corporations and individuals. I think we’re going to do that. I think that because we do it every 32 years, and the time is up. I think we’re going to do it because both parties say they want to do it.
And because there is bipartisan appeal. The Democrats want to get rid of all these loopholes and credits. Republicans want lower rates. Those two go together. What I’ve found in other countries is you have to do tax reform big. You can’t just do one piece of it. If you go after the whole thing, then everything that people lose that they liked is offset by something new that they get. They get a lower rate or a simpler form, and the politics work out. Just looking at other countries, it works there, it would work here, and I think we’re going to do it. I think the time has come where people are so fed up with our tax code that we’re going to make this fix.
Knowledge@Wharton: If we make all these changes and we can’t make it simpler, it is going to put companies like H&R Block and all these other ones right square in the forefront of trying to change their business model and figure out how they can be successful in this process.
Reid: Yes, that’s right. And if we did simplify the code — which we ought to do — it probably would mean Americans would not have to pay money to H&R Block, etc., and some people would lose their jobs. But you know what? That happens in a vibrant society. We used to have a lot of people employed making typewriters in America. They had to move on to other jobs. It used to be that every city, including Philadelphia, paid a squadron of people to sweep up the manure behind the horses pulling carriages. That industry is gone.
Vibrant societies adapt. If we don’t have to spend money to pay somebody to fill out an incomprehensible tax return, that person can go do some more useful line of work. That’s what happens in innovative society.
Article by Knowledge@Wharton