Monday, December 15, 2008

Why the U.S. Federal Income tax is so Hard to Reform

Since President Reagan’s 1986 tax legislation, which broadened the tax base and lowered tax rates, every subsequent proposal to reform the federal income tax has come to naught. Indeed, the length and complexity of the code continue to grow topsy. Every group that benefits from a new provision becomes another political constituency for keeping and expanding it.

Several proposals for heath care reform, if enacted, would create another large interest group that will hamper future efforts at tax reform. Under current law, employer-provided health insurance to employees is not subject to individual taxation, whereas those who buy insurance on their own must pay for it out of after-tax income. One proposal suggests leveling the playing field by eliminating the exemption for employer-provided insurance, but its authors argue that eliminating that benefit would face enormous political opposition. Accordingly, they recommend that individual purchasers of insurance receive a tax deduction. On its face, this seems fair, and would likely extend coverage to some currently uninsured. The problem is that this new tax benefit, like so many before it, would further make the federal income tax impervious to comprehensive reform.

The same applies to special tax benefits for education, energy, green technology, housing, and so on. Why is that some, but not other, endeavors are to be encouraged and rewarded with tax benefits? Why not give the entire economy the benefit of lower rates?

The way to reform the tax code is to broaden the base and lower the rates (preferably to a low flat rate). Advocating new deductions and/or credits only makes it more difficult.

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