OK, I admit it. I like doing my taxes. This annual ritual gives me the chance to sit down and reflect on the financial year that just passed and to think about my family’s financial future. Tax time reminds me to spend a bit less and put a bit more into savings.
Filing your taxes is also one of the few common experiences that virtually all Americans share, and complaining about tax day and the IRS — in a somewhat perverse way — brings all of us closer together.
But unlike most Americans, I also have a professional interest in the tax code. As an economist and tax analyst, part of my job is to keep an eye on the tax code and tax revenue and to think about how to make the tax code better. By filing my own taxes (and not using a paid preparer like half of tax filers (PDF) do), I try to get a better sense of where things should be changed.
There’s no question that the tax code does need to be improved. But we must also take time to marvel at what it does accomplish. In 2005, the federal government raised over $2 trillion, about half of which came from individual income taxes. Social Security taxes made up a good share of overall revenue (about $800 billion), with corporate taxes, excise taxes (on goods like alcohol, tobacco, and phone services), and the estate tax making up most of the rest. (See figure below.)
The nation’s ability to raise this revenue means that we can, as a country, pursue national goals, such as providing for national security, building bridges and roads, investing in scientific and medical research, supporting our elderly, and educating our children. Maintaining these public structures with adequate funding is part of what keeps our economy and our nation strong.
Most Americans realize the importance of fiscal responsibility and the need to pay for national expenses. In a recent poll by the Pew Research Center, 79 percent of respondents said that “not reporting all income on your taxes” was morally wrong. Just five percent believe it is morally acceptable.
But there is also much that can and should be improved about the code. During the last holiday season, my wife and I decided we wanted to help start a college fund for a new nephew. Writing a check was the easy part, and we knew that there was probably some kind of tax-advantaged educational savings programs that might be available. Now, I’m a tax expert, and the baby’s father is a schoolteacher, so you’d think we’d be able to easily figure out how to best navigate the tax incentives for education. But you’d be wrong. The complexity of tax incentives for higher education is mind-boggling — just take a look at the 82-page IRS Publication 970 (PDF). For example, there is the federal Coverdell account program, and each state has its own “529” plan (and several states have more than one). There are various contribution limits, withdrawal penalties, fees, and other rules to figure out. The system is a giant catch-22 — you need to have a college degree to figure out how to get to college.
And this is just one example of many. There are several, equally complicated tax-preferred ways to save for retirement. Also, low-income taxpayers, who cannot afford some of life’s basics, nevertheless find it necessary to pay private companies to fill out their tax returns — nearly 70 percent of those receiving the Earned Income Tax Credit use a paid preparer, which is more than the population as a whole.
Beyond having an overly complicated tax code, there is also a basic notion of fairness that is violated in the current system. Since most people do not itemize, most deductions in the tax code are simply benefits for other people. And those in higher tax brackets receive a greater benefit from these deductions as well.
A solution to some of these problems would be to simplify the code by consolidating the tax treatment for education, retirement savings, and in numerous other areas. And we should adhere to the principle that everyone should be eligible for a tax incentive at the same rate, no matter your income. In tax speak, this means changing deductions into refundable credits. (The Center for American Progress recently held a tax conference to highlight several suggestions for tax reform; click here for more information.)
Most of what I said above is about fixing the details of the code, not about the overall level of revenues. But we cannot ignore the fact that the country is not raising enough revenue to finance our national priorities. The president and his Congressional allies have turned a record surplus into a massive deficit of close to $400 billion, and experts all agree that the imbalance will not simply go away without major changes in policy.
As a further issue of fairness, it needs to be recognized that once the payroll tax is factored in, the wage income of average taxpayers can easily be taxed at twice the rate that millionaires pay on income from their wealth. This is because employees and their employers must each pay 7.65 percent in payroll taxes — a combined 15.3 percent — on top of their income taxes, and millionaires pay a maximum rate of just 15 percent on their income from capital gains and dividends.
The Bush administration’s radical tax policy has created or made worse these problems, and we need a fiscally sound change in direction. This means reversing the tax cuts for those at the top, ensuring that hard work is rewarded, and making the tax code work for low- and middle-income taxpayers, not against them.
This year, the downside of filling out my own taxes was finding that my wife and I had not been withholding enough throughout the year, and that we will have to write a sizeable check to the IRS. Like millions of others, I will curse the IRS on April 17. But for the rest of the year, I will be proud that I did my part.
And in case the IRS is reading this: The check is in the mail.
John S. Irons, Ph.D., is Director of Tax and Budget Policy at the Center for American Progress.