If Form 1040 Has Taxed Your Patience, New "flat Tax" Schemes May Lead to Many Happier Returns
As the 95 million people who recently filed their income taxes can testify, filling out a Form 1040 nowadays is only slightly easier than solving a Rubik's Cube in the dark. The mare's nest of schedules, shelters, deductions, rates and tables leaves millions of ordinary taxpayers feeling like chumps, and has sparked a nationwide call for tax simplification. Perhaps the most popular form of proposed relief is the sweeping and radical "flat tax"—a levy that, in its pure form, would simply tax everyone at the same rate. Several flat tax bills are currently before Congress, supported by such political opposites as consumer advocate Ralph Nader and archconservative Sen. Jesse Helms.
To find out more about the flat tax concept, Washington correspondent David Van Biema talked with economist Joseph Pechman, 66, who for 21 years was Director of Economic Studies at Washington D.C.'s Brookings Institution. Currently on leave from Brookings and a visiting scholar researching tax policy at Stanford University's Hoover Institution, Pechman always fills out his own federal return and claims never to have stayed up past midnight on April 14.
Why does the income tax system need to be changed?
For at least the 23 years I have been studying it, the tax system has gotten steadily worse.
In what way has it gotten worse?
The income tax we have now is simply unfair. People with the same income and family size will often pay very different federal income taxes, depending on the source of their income and whether they take a lot of deductions. Take two single people with $15,000 in income: one person who receives $5,000 in unemployment compensation and $10,000 in salary and another person who earns $15,000 in salary. Under the present law the person with the $15,000 salary pays a higher tax than the person who received a share of his income as unemployment compensation.
Are there other problems?
The law has become excessively complicated. It is impossible for the average taxpayer to understand his or her tax return, so millions of people have to pay someone to figure out their taxes. I regard that as a terrible state of affairs.
Why is the system so complicated?
Congress has been trying to do too much with the income tax. For example, there is the problem of how to improve job opportunities for the unskilled and the handicapped. There are methods of providing training and subsidies directly to these workers. But now we have a "jobs credit" in the tax system for employers who hire them. We do a lot of things with the tax system that could be done more efficiently by other government agencies.
Is there anyone who completely understands the current system?
There are certainly people who think they do, but even tax lawyers and tax accountants who work for the government disagree about what the tax law means. The code has become bigger and bigger; it's now printed in books where the print is so small, it's almost unreadable. A former Undersecretary of the Treasury recently told me that when he first became a tax lawyer in the mid-'30s, he was given a week to read the code. Today, he said, he might be able to read it in six months.
So it is these two problems—lack of fairness and the excessive complexity of the tax code—that the flat tax tries to solve?
Yes. By getting rid of tax preferences and by taxing everybody at the same rate, it tries to do both things. Of course, most of the versions of the flat tax that Congress is considering are modifications of the pure flat tax.
How are they modified?
Most of them still maintain some gradation of rates, although certainly not as many as the 14 tax brackets we now have on the books. And most of the proposals would not completely eliminate all the deductions and exclusions. But some of them go quite far in that direction.
Of the flat tax bills now before Congress, which has the best chance of succeeding?
The bill proposed by Sen. Bill Bradley (D-N.J.) and Rep. Richard Gephardt (D-Mo.). They have made the bill a major issue and talk about it all over the country.
What does their plan entail?
Bradley-Gephardt proposes having a normal, flat rate of 14 percent that would apply to most people, and two higher rates for married people with incomes above $40,000 and single people who make more than $25,000. The top rate would be 30 percent.
Which deductions would the average taxpayer lose?
He or she would no longer be able to write off state and local sales tax, non-mortgage interest and the $100 dividend exclusion, among others.
Would any deductions be left?
Bradley-Gephardt would allow deductions for charitable contributions, state and local property and income taxes, medical expenses, child care, mortgage interest and existing IRAs and Keoghs.
Why are so many deductions maintained if the whole idea is to get rid of them?
These are political compromises. The logical thing to do would be to eliminate all of the preferences. But if politicians did that, all hell would break loose. It would raise such opposition from groups like homeowners, the aging and the real estate lobby that it could never pass.
If the bill does pass, what effect will it have on the average person's taxes?
This is a very important point. For most people—about 80 percent of taxpayers, by my calculations—the amount of tax paid will change very little, up or down. What the flat tax does is make the process simpler and close up a lot of the loopholes.
How would the very poor make out?
We have a tradition of not taxing very low income people, and the flat tax idea provides for that. In fact, Bradley-Gephardt would raise the level at which a family of four begins to be taxed, from $7,400 to $11,200.
What about the very rich? From 1975 to 1977 Nelson Bunker Hunt, a billionaire, paid less than $10 in taxes.
The wealthy would have far fewer preferences open to them under a flat tax. They could still invest in tax-exempt securities, such as state and local bonds, but most tax loopholes, such as cattle farms, timber, coal and windmills would disappear. The advantages of tax shelters would practically be wiped out.
Shouldn't closing all these loopholes bring in more revenue, and thus help narrow the deficit?
Not really. Bradley-Gephardt, for instance, would bring the government the same amount of money as the present system. The government could afford the lower tax rates because the bill would eliminate most deductions.
Does the flat tax face an uphill battle?
Definitely. Pressure groups will try to stomp on the bill. But the Democratic Party has come out in favor of flatter tax rates and Administration officials are reportedly studying the possible effects of similar reforms.
What will it take for the bill to succeed?
The President—a popular President—will have to get behind it.
If it does pass, won't a lot of tax lawyers be out of business?
I certainly hope so.
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