The Certainty Of Taxes

January always seems to be one of the toughest months of the year. It’s the time of year when the season of good cheer exemplified by welcoming salutations, glutinous consumption, holiday adornments, and toasts to auld lang syne and prosperous new years is replaced by the realities of life: credit card bills, bent resolutions, overstuffed cardboard boxes of decorations heaped back into basements, and for those in the northern hemisphere, the true beginning of the dark months of winter.

It is only apropos, therefore, that this is also the month when many in the United States will begin to collect and consolidate documents from the past year in preparation for the long and arduous process of filing annual taxes with the Internal Revenue Service (IRS). Sure, most of us don’t truly put the full effort into tax preparation until February or March, but this dark cloud is always lingering in the background, as banking statements, brokerage statements, W-2s, and mortgage interest payments begin replacing the beaming faces on holiday cards from family and friends.

“Taxes are what we pay for civilized society.” ?Oliver Wendell Holmes, Jr.

The late U.S. Supreme Court Justice made a valid observation. Paying taxes is the cost of admission to live and share in the resources as provided by a country that’s as self-sufficient, economically potent and free as America. We all get that. In a real sense, U.S. taxes are a necessary evil to support the foundational benefits shared by all Americans, including roads and infrastructure, defense, health and safety, education, healthcare, environment, national parks, and social programs. Yet, the process of collecting these civic payments should in no way be as complicated as the U.S. government affords.

The current U.S. tax code is said to be nearly 74,000 pages, or roughly 185 times longer than the 400 pages in 1913.1 From 2001 to 2012, 4,600 changes have been made to the U.S. tax code – about one change per day.2 It is estimated that businesses and individuals collectively spend upwards of 6.1 billion hours per year preparing and complying with tax-filing requirements.3 That’s equivalent to more than 695,000 years of effort.4 Keep in mind, this figure was actually determined by the IRS, raising the complexity of the Internal Revenue Code as one of most serious problems facing taxpayers back in 2012.

While the 74,000-page figure cited above is technically correct, it is admittedly more of a sensational dramatization of the tax code than what is truly used by taxpayers. In reality, the tax code actually used by businesses and individuals is closer to 2,600 pages.5 The 74,000-page figure includes pages from the CCH Standard Federal Tax Reporter, a collection of resources and documents for tax lawyers and accountants used in preparing tax filings, containing legislative history, Treasury regulations, editorial commentary, and court records on each topic. Yet, even assuming the reduced figure of 2,600 pages, the tax code remains considerably more complex than required as compared to some of other well-known literary tomes (Figure #1).

Fig. #1

Comparison Of Page Count For Various Documents

Source: EverBank Research Team, based on an analysis of publicly available data from Wikipedia, Slate Magazine.

More Loops Than A Coney Island Roller Coaster
Most of the complexity in the U.S. tax code has resulted from the special interest perks, political pork, and social add-ons that have ultimately rendered the document virtually untenable. And, of course, when there are special interests, there are lobbyists and money close behind. In 2014, there were 11,200 requests from about 1,800 clients for favored treatment in pending tax code modifications.6 As illustrated in the recent 2015 tax-and-spending bill, lobbyists from the hotel, restaurant, and gambling industries added 54 words to the omnibus bill preserving a tax loophole that allowed these industries to protect the taxability of assets placed into real estate investment trusts, collectively saving these industries an estimated $1 billion in future tax liabilities.7

And, these are just lobbying efforts from corporations. A recent article in The New York Times detailed the efforts by the ultra-rich to gain favorable tax treatments, deploying teams of tax lawyers and millions of dollars to exploit arcane legislative procedures or negotiations directly with the IRS to tweak tax codes in their favor.2

As evidence that the strategy has been successful, the rate at which the highest earning 400 taxpayers in America paid Federal taxes was 17% of earnings in 2012, compared to 27% of earnings in 1995.8 In turn, these tax rates have allowed the top 0.001 percentage of earners (those with 2013 annual income above $45 million) to experience an average tax rate similar to individuals in the top 4% of wage earners (those claiming $200,000 in adjusted gross income) (Figure #2). These issues do not even address those related to the tax breaks for wealthy professional sports team owners, hedge fund managers, or sports franchises such as the NFL, NHL and PGA.

Fig. #2

Average Tax Rate Percentage – Calendar Year 2013

Source: EverBank Research Team, based on an analysis of publicly available data from the IRS, Statistics of Income Division (August 2015).

Issues with tax loopholes are certainly not limited solely to the high-end of wage earners. It is estimated that the popular Earned Income Tax Credit has been plagued with fraud over the past 10 years, with up to an estimated 29% of all payments potentially questionable through this tax credit.9 It is further estimated that the IRS has paid out $125 billion in fraudulent claims over the past 10 years.10 As such, it appears clear that the more programs, incentives, and loopholes added to our burgeoning tax code, the less efficient it becomes.

Who Eventually Pays The Taxes
As calculated from the figure below, roughly 97% of U.S. taxes are paid by the top 50% of income earners, with 58% of total taxes paid by the top 5% of income earning individuals (Figure #3). As a reference point, in 2013, the minimum adjusted gross income per year for the 50% and 5% tax brackets was $36,841 and $179,760, respectively.

Fig. #3

Percentage Share Of Total Tax Payments vs. AGI – Calendar Year 2013

Source: EverBank Research Team, based on an analysis of publicly available data from the IRS.

Despite some claims to the contrary, those in the higher tax bracket are paying a greater share of taxes as a percentage of adjusted gross income. Obviously, these figures are based on averages, and may not reflect some individuals in the ultra-high tax brackets. The larger issue for many individual tax payers may not be the income disparity, but rather, the broader share of taxes collected by the U.S. government. Some 46% of total income collected by the U.S. government came from individual income taxes, while an additional 33.9% was funded from payroll taxes (typically shared by employer and employees for Social Security or Medicare). Conversely, corporate taxes contributed only 10.6% of total income tax receipts (Figure #4).

Fig. #4

How The U.S. Government Is Funded – 2014

Source: EverBank Research Team, based on an analysis of publicly available data from Pew Research Center.

In relation to historic corporate tax payments, the same chart above during the 1950s would have shown corporate income taxes closer to 25% or 30% of allocation.11 Since 1980, inflation-adjusted gross domestic production (GDP) has increased 149%, while corporate tax receipts were up only 85% during this period.11 Large multinational corporations have teams of tax lawyers that either find or lobby for methods to reduce taxes, including running income through low-tax subsidiaries, maintaining income oversees to avoid repatriating profits generated in foreign countries, or reincorporating in tax-advantaged countries.

The next 10 months should be interesting with respect to the 2016 presidential race, and how candidates will position their platforms to address the onerous complexity of the U.S. tax code. I would hope that the candidates will eventually address the issue of the U.S. tax code, in particular, closing tax loopholes and tackling falling corporate tax contributions relative to GDP, but this remains to be seen.

Until the next Daily Pfennig® edition…

Chuck Butler
Managing Director
EverBank World Markets, a division of EverBank