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                Ö!M"⌐                                                      ╚IDEAS, Page 48

How to Simplify the Crazy Tax Code


Down with the income tax!

A growing number of economists say the U.S. needs a consumption
levy that rewards thrift and enterprise and cuts down on those
maddening forms

By DAN GOODGAME/WASHINGTON -- With reporting by Bernard Baumohl/
New York and Elaine Shannon/Washington


    Americans have always hated taxes, from the Boston Tea
Party to "Read my lips." But this year -- this week -- the
nation's enmity carries a new emphasis. Taxpayers are angered
not only by how much they pay but also by how little the other
guy pays, by the sense that the system is somehow corrupt, and
by the reality of just how complicated the tax codes are. A poll
conducted late last month by the New York Times and cbs found
that 59% of Americans considered the federal tax system to be
unfair.

    Their feelings are aggravated by the growing realization
that despite all the talk of simplification in recent years,
the laws are now more complex, not less. The last effort at tax
reform, in 1986, has instead brought "more complexity, a
reversal of the trend toward more progressivity . . . and a
dramatic slowing in the rate of U.S. job creation," concluded
a recent study by former Treasury Department tax experts Gary
and Aldona Robbins.

    Economists and politicians of many stripes charge that the
1986 reforms have dragged down the U.S. economy by punishing
hard work, thrift and investment while encouraging Americans to
borrow and spend beyond their means. Council of Economic
Advisers chairman Michael Boskin argues that the 1986 law
"sharply reduced incentives for investment, and we're paying a
price for that in slower growth." Liberals attack the current
system as both unfair and unproductive. Robert Shapiro, a
domestic-policy adviser to Democratic presidential front runner
Bill Clinton, charges that "our tax code has been encrusted with
layer upon layer of distortions of market signals . . . It
undermines the productivity of the entire economy."

    No wonder Jerry Brown's proposed "flat tax" of 13% on
income -- allowing deductions only for mortgage interest, rent
and charitable contributions -- combined with a 13% national
sales tax on goods and services has found so much resonance in
the current campaign. But the Brown plan is not well thought
out. It would raise taxes on the working poor, cut taxes on the
wealthy and further swell the budget deficit. It is more
simpleminded than simple, less a plan than a slogan.

    Nevertheless, Brown may be onto something. Behind his flat
tax is the basis for real American tax reform -- an idea that
has been around for years but now is gaining intellectual
support and public attention.

    What makes sense, many economists are arguing, is to junk
personal and corporate income taxes altogether for a single
"direct-consumption tax" on what people spend rather than on
what they earn. In some ways, a direct-consumption tax would
resemble a reformulated income tax: it would be assessed by
calculating an individual's total income and subtracting the
amount that he or she saved and invested. All forms of income
would be counted, including wages, interest, dividends, capital
gains, Social Security benefits and employer-provided health
insurance. The savings and investments that could be deducted
might include spending on education and job training. A similar
formula could be used for taxes on businesses.

    Such a consumption tax would allow few deductions for
individuals or companies: none, for example, for mortgage
interest or business lunches. But it would end the double
taxation of dividends and savings that takes place under current
law, and it would enhance exports, which would be freed of U.S.
taxes now incorporated into their price when sold abroad.

    Ironically, Ronald Reagan's 1986 tax reform was inspired
in part by a golf-course conversation with George Shultz, his
Secretary of State, who praised the same 1981 consumption-tax
plan, authored by Stanford economists Robert Hall and Alvin
Rabushka, on which Jerry Brown claims to have (very loosely)
based his current proposal. One of the most elegant
consumption-tax plans was crafted even earlier, in 1977, by
economist David Bradford and his Treasury tax-policy staff.

    Until now, the consumption tax has never caught on
politically, largely because it was considered too regressive,
meaning that it was too favorable to the wealthy at the expense
of other taxpayers. While that may be true for crude plans like
Jerry Brown's, it is not immutable. A consumption code can be
made as progressive as one wishes, by adding brackets (the 1977
Treasury plan proposed brackets of 10%, 28% and 40%) and
generous exemptions (Hall-Rabushka would not tax the first
$16,000 of income). A consumption tax also would tax gifts and
inheritances like any other income, unlike current law, which
favors the rich. And since even wealthy taxpayers spend nearly
as much as they earn over the course of their lives, the
consumption tax can eventually collect as much from them as
would an income tax, and more efficiently. A consumption tax can
-- and should, for political appeal -- be designed so that a
large majority of taxpayers would pay slightly less than they
do under current law, while the wealthiest would pay slightly
more.

    Beyond its intrinsic merits, the consumption approach
would go a long way in redressing other key weaknesses in the
existing tax system:



    -- TIME. The IRS says it takes about 17 hours for the
average family to keep records and prepare an itemized Form 1040
with a few additional schedules. But try to factor in income
from a part-time business or account for taxes paid for in-home
child care, and the filing time can eat up several weekends, or
$1,000-plus in accountants' fees. Nearly 53 million Americans
-- almost half the individuals filing income tax returns each
year -- pay for help in filing.

    Among them, Forbes magazine discovered, are 11 of the 12
senior members of the tax-writing committees in the House and
Senate. The only member of this club who prepares his own
return, Congressman Bill Archer, a Texas Republican, says he
understands why so many constituents complain that "it's so
expensive to get returns prepared, compared with a few years
ago."

    The burden on business, especially small business, is
worse. Many sole proprietors find they need to buy computers or
hire accountants to comply with irs record-keeping requirements
for inventory. Some small businesses are required to deposit
withholding taxes for their employees as often as eight times
a month. One sentence in a tax instruction used by many
small-business owners runs 436 words -- longer than the
Gettysburg Address.



    -- MONEY. The cost of all this tax paperwork is
staggering. Estimates of the direct costs of tax compliance --
accountants' and lawyers' fees, time spent by individuals and
businesses on record keeping and form filing -- range from $40
billion to $232 billion. The indirect costs to the economy of
tax laws directing resources away from their most efficient uses
are difficult to measure but are estimated to exceed the direct
costs. Peter Faber, a top New York City tax lawyer who charges
$400 an hour, concedes that "the whole industry of tax
specialists would not exist but for the complexity of the tax
code. Otherwise, we would be doing something constructive like
building bridges."



    -- TRUST. The complexity of the code also gives rise to
public cynicism that the whole tax system is a game rigged in
favor of the wealthy and powerful. Carolyn Stradley, owner of
an Atlanta paving company, says, "I don't have any proof, but
I'll bet I pay more taxes than Lee Iacocca," the chief executive
of Chrysler. In fact, the tax reforms since 1986 -- particularly
the Alternative Minimum Tax so despised in Republican circles
-- have prevented most wealthy individuals from avoiding taxes
altogether. But the wealthy have certainly seen their taxes
diminish overall, even as taxes have risen for most Americans.
Ninety percent of taxpayers pay a larger share of their income
to federal taxes than they would if the tax system had not
changed since 1977, while the wealthiest 10% pay much less.

    Despite its advantages, a consumption-based tax system
carries one crucial drawback: getting from here to there would
turn the economy inside out and would require an expensive
(about $25 billion, by one estimate) transition period in which
to phase out such deeply rooted elements as the tax deduction
for borrowing by companies and homeowners. The changeover would
cause great uncertainty, which most businessmen and investors
despise as much as they do high taxes. Such a sweeping revision
of the tax code would be resisted most ferociously by the
special interests, led by real estate and oil, who benefit from
favored tax treatment under current law and who are major
political contributors.

    Even if adoption of a direct-consumption tax is not
immediately possible, several interim reforms would relieve the
current system of its worst offenses. The first would be to cut
the regressive Social Security and Medicare payroll levy, which
has doubled over the past decade, by at least 2 percentage
points, to 13.3%. To make up for this lost revenue of about $53
billion, apply the tax to higher income brackets, or increase
excise taxes on gasoline, alcohol and tobacco. Cutting the
Social Security payroll tax not only would promote fairness, it
would also create about a million new jobs, which is why it is
supported by the conservative Heritage Foundation and the U.S.
Chamber of Commerce.

    In addition, the deduction for mortgage interest could
immediately be capped at $20,000 a year and eliminated for
second homes and vacation homes. Other tax breaks that could be
phased out: the deductions for business entertainment, the
exemption for inherited capital gains and the exemption of all
entitlement benefits such as Social Security and Medicaid.

    These reforms share a common goal of reducing the extent
to which tax policy influences economic behavior. But another
change would tax activities that impose costs on society: a levy
on pollutants and greenhouse gases. Larry Summers, an economics
professor on leave from Harvard, for example, calculates that a
tax directed at halving the growth of carbon dioxide emissions
would raise $16 billion a year, while increasing the price of
gasoline only about 5 cents a gallon. The tax cut could raise
twice as much money and still keep U.S. energy prices below
those in Germany and Japan.

    The revenue gained from these changes -- at least $66
billion -- could be used to further reduce tax burdens on
middle-income wage earners and on the activities that the
economy needs to encourage: working, saving and investing. At
the end of any transition, these are goals worth the disruption.