There is nothing like the IRS Form 1040 and New York State Form IT-201 to get you in the mood for tax reform.
We need a simpler system. Complexity is expensive in itself: We spend money simply keeping records and paying professionals to figure out what we can and can't claim. The Taxpayer Advocate Service estimated in 2010 that taxpayers spend 6.1 billion hours filling out taxes each year (down from an estimated 7.6 billion hours in 2008, probably courtesy of tax software). Sixty percent of Americans pay someone else to have their taxes done. In 2008, TAS put the total cost of compliance at $163 billion, about 11 percent of total tax receipts.
The number and complexity of tax breaks opens the system to special interests-although my "special interest" may be your "critical need." Having fewer tax breaks would let us cut rates, simplify reporting and make the whole system more transparent. Both at the state and federal levels, our tax system looks like a Christmas tree that's been decorated by 6-year-olds-no order, and too many ornaments.
Take New York. Thirty-four credits adorn the New York personal income tax-all good things, of course. There's the farmer's property tax credit and the green building credit and the credit for purchasing an automated external defibrillator. We have a credit for volunteer firefighters, biofuel production, solar energy equipment purchases and rehabbing historic homes. Some cost little; the green building credit cost us $400,000 in 2012. Some are sizable: Child care and dependent care credits cost $341 million, and the college tuition tax credit cost $287 million.
Meanwhile, the corporation franchise tax includes credits for historic barns, land conservation easements, security training and film production (movies, not Kodachrome). Again, the cost varies. Security officer training cost about $300,000, but credits to the motion picture industry totaled about $340 million.
The state sales tax is a patchwork quilt. Food sold at senior citizen housing communities or through vending machines is exempt, as are pollution control equipment, machinery and equipment used in production, and food sold to airlines.
What's the problem? Tax preferences fly "under the radar," making them easier to pass and harder to cut. Unlike budgeted expenditures, they are hard to measure and typically are open to all comers, thus effectively unlimited.
Federal exemptions that affect state taxes also are numerous. The exclusion of capital gains on home sales is expected to cost New York $1 billion in 2012. Capital gains on inherited property also escape taxation, costing the state an estimated $1.1 billion. (See the state Department of Taxation and Finance's report at http://goo.gl/CRn0F for more detail.)
At the federal level, the size of the tax-break problem is well-documented. Called "tax expenditures" by wonks, these are activities "financed" by agreeing not to collect a tax. The Congressional Budget Office regularly publishes an estimate of such tax breaks. A recent report showed that tax expenditures-those taxes we agree not to receive-cost us more than Medicare, defense or Social Security. Eliminating tax expenditures would be nearly equivalent to doubling social insurance taxes.
Eliminating tax breaks is easier said than done. Certainly some are egregious and would likely disappear if put to a vote. Yet many-think of the mortgage interest deduction and the exclusion of capital gains from residential real estate-have a broad constituency. Probably most are well-intentioned. Some-consider the earned income tax credit-are a critical part of our social safety net.
The problem even has a local flavor: New York industrial development agencies often are petitioned to confer tax breaks on local businesses burdened by high cost and vigorous competition. If a business would leave without assistance, the net benefit is clear. Yet when the tax break goes to a firm with local competitors, the benefit to one may be offset by harm to another. The taxes of one may support a tax break for another.
In my rare utopian moments, I look for a leader who will broker a grand compromise that sweeps away myriad preferences, simplifies the tax system and puts our economy on a sound fiscal path. Unfortunately, the debate from now through the election will be reduced to a false choice between spending less or taxing more, between a Paul Ryan budget that many people won't support and a "Buffett Rule" with only symbolic impact.
Kent Gardner is president and chief economist of the Center for Governmental Research Inc.4/20/12 (c) 2012 Rochester Business Journal. To obtain permission to reprint this article, call 585-546-8303 or email email@example.com.