Promises. Promises. Promises. Will The U.S. Tax Code Ever Get Changed?

Promises. Promises. Promises.
Will The U.S. Tax Code Ever Get Changed?

“If you drive a car, I’ll tax the street.
If you try to sit, I’ll tax your seat.
If you get too cold, I’ll tax the heat.
If you take a walk, I’ll tax your feet.”

The Beatles, “Taxman”

The lyrics from that great Beatles tune still ring as true today as they did back in 1966 when the influential Revolver album was released – maybe even more so. As the 2016 tax year gets placed in the books, it’s only natural to think about where the U.S. tax system goes from here. By all indications, 2016 will likely be another stellar year for the U.S. Treasury, collecting a record $695 billion in individual taxes through the first six months of the Federal fiscal year ending September 2017,1 and on its way to a budgeted $1.5 trillion in individual income taxes.2

The last Federal tax code refresh occurred back in 1986 – in an effort to simplify the tax code, broaden the tax base, and eliminate tax shelters. 3 Which begs the question: Will the 2017 tax year bring more of the same, or will it usher in a new chapter in U.S. tax law reforms?

The “success” in current year tax collections, of course, comes at the expense of individual taxpayers, who appear to be shouldering a greater burden of payment each tax year. Based on 2016 data, the U.S. Treasury collected 52% of the government’s revenue from individual income tax payments, while corporations provided roughly 14% of tax contributions, and import, production and other taxes accounted for the remaining 34%. Yet, compared to a decade earlier when individual tax collections accounted for 48% of total receipts, it is clear that the burden on individual U.S. taxpayers has increased relative to corporate tax receipts and other sources (Figure #1). This calculation does not even include contributions to government social insurance funds from both individuals and corporations, which combined represents an additional $1.18 trillion in collections.4

Fig. #1
U.S. Treasury Revenue Receipts By Source
2006 vs. 2016

 

Source: U.S Bureau of Economic Analysis

At the same time, the number of taxpayers actually paying Federal income taxes continues to compress. Based on 2014 data, more than 139 million returns were filed with the U.S. Internal Revenue Service during the year. Of these 139 million returns, the top 5% of tax filers who earned at least $188,000 paid about 60% of total taxes collected during the year, which compares to this cohort’s 37% contribution to total taxes during 1980.5 Moreover, the top 50% of tax filers paid nearly 97% of all income taxes collected during 2014, meaning those filers reporting income of less than $38,000 paid just 3% of the total tax liability, despite representing just over 11% of total adjusted gross income (Figure #2).

Fig. #2
Summary Of Federal Income Tax Data
Fiscal Year 2014

 

Source: Internal Revenue Service Statistics of Income

Tax Preparation Is Big Business
So, if you are one of those citizens maintaining membership in the club that’s still contributing to paying income taxes, you are probably licking your wounds right about now after wrapping up yet another year of paying frustrating U.S. Federal income taxes. That is, unless you are one of the 10% of individual taxpayers filing for the automatic 6-month extension,6 needing more than the average eight hours to work through the 74,000 pages of tax code to file those 2016 U.S. Federal income taxes.7 Businesses have typically incurred an even more burdensome process for filing annual taxes, spending an average of 23 hours of preparation at an average cost of $420 per firm, and an incremental 55 hours of time and expenses to maintain compliance with labor and health care tax requirements.8

Adding insult to injury, most taxpayers now choose to incur additional filing expenses to hire tax preparation services rather than navigate the increasingly complex tax code. Just speak with any small business owner, and most will agree that paying a professional tax preparation firm is now necessary based on the intricacy of filing. The complexity of the U.S. Federal income tax process has been a veritable gold mine for the tax preparation industry, estimated to exceed $11 billion in revenues by the 2018 tax season.9 Based on data collected by the Internal Revenue Service (IRS), as of April 7, about 57% of all tax filers for FY2016 used some level of tax preparation methodologies, whether through a paid preparer, the IRS, volunteer tax assistance, or tax counseling services for the elderly.10

The kicker is that many tax filers with adjusted gross income below $30,000 felt it wise to use some form of tax preparation service to make sure they received allowable credits. Despite having virtually no tax liability, 58% of tax filers approximating the bottom 50% of income generation felt it necessary to use tax preparation services to make sure they correctly filed U.S. Federal income taxes in order to collect various Federal tax benefits.11 Ironically, in order to receive refundable tax credits such as the earned income tax credit or child tax credit, low-income families felt the need to pay for the preparation of annual filings to be sure they got these tax benefits. Only in the U.S. tax code would a low-income family feel the need to seek the services of a professional tax preparation service to be assured of receiving promised tax benefits of anti-poverty programs.

Is Tax Reform On The Way?
Since the last major tax reform was completed in 1986, the tax code has increased from roughly 30,000 pages to over 70,000 pages.12 With 30 years passing since the last tax reform, it would seem time for a major reboot to the U.S. Federal tax code.

In addition to the above discussed inefficiencies, a Heritage Foundation research study completed in 2016 found that the current U.S. income tax code stifles economic activity, citing high tax rates for individuals and investors; marginal tax rates that discourage work, savings, investment, and risk taking; politically motivated tax credits and incentives; and the highest corporate tax rate of any developed country in the OECD (Organization for Economic Cooperation and Development).13

Similar to virtually every presidential campaign platform over the past two decades, one of the Trump administration’s key platforms during the 2016 election campaign was reforming the U.S. tax code. This included simplifying the tax code and providing tax relief for middle class Americans. President Trump’s early approach to tax reform included a three-pronged strategy that involved dramatically reducing corporate tax rates, providing incentives for corporations to repatriate the roughly $2.5 trillion in capital held in overseas accounts, and completely reforming the individual income tax code.14 If successful, the administration is expected to push towards simplifying the individual tax code, eliminating the alternative minimum tax (AMT) and the marriage penalty, lowering corporate tax rates for large and small businesses, and eliminating estate taxes,15 among other initiatives.

In particular, the Trump administration has discussed simplifying the ordinary income tax code from the current seven tax brackets ranging from 10% to 39.6% to three ordinary income brackets at 12%, 25%, and 33%, in an attempt to both lower income tax rates as well as reduce the marginal tax problem by reducing tax zones. The administration’s early proposals have also included simplifying the tax preparation process by removing most deductions and credits save for the mortgage interest and charitable giving deductions, and replacing these with much higher standard deductions for single and joint filers.16

As the failed action on a populous health care reform movement clearly illustrated, there is nothing in politics that should ever be considered a “layup.” Nevertheless, a recent survey on tax fairness conducted by WalletHub determined 75% of respondents rated the current tax code as either complex or extremely complex.17The consensus appears to be growing for reform and simplification of the income tax code for both individuals and corporations. Loyal readers of the Daily Pfennig® newsletter can only hope that by this time next year, the persisting Beatles’ “Taxman” tune may perhaps finally fall silent on taxpayer ears.

Did you use the services of a tax preparation firm or other resource to do your 2016 taxes? If you prepared your own taxes, approximately how many hours did you spend? Let us know by posting your thoughts in the Comments section of our blog.

Until the next Daily Pfennig® edition…

Sincerely,
Mike Meyer
Vice President
EverBank World Markets, a division of EverBank
1.855.813.8484
everbank.com