As fee-only financial advisors, the fall often means some hands on year-end tax planning for our clients. Couple that with recommendations of early filing in the wake of the Equifax data breach and news of a tax reform proposal, and it got us thinking about our tax system. What’s the history behind it and what might be in store moving forward?
Is the US tax code really that complicated? Why?
In a word: yes. In 2.4 million words on 73,000 pages, the US tax code is extraordinarily complicated. Started in 1913, the federal income tax focused only on the highest earners. In 1922, Congress expanded this to a comprehensive tax code. Over the next 30 years, countless loopholes, exemptions and credits were added that complicated the code. In 1954, the convoluted nature of the tax code met its upward limit and required major reform. History seems to have repeated itself ever since.
Even with "financial advice" websites available for free on the internet, all that complication means time and money. Americans spend about 6 billion hours collecting information to file our taxes. Then, we spend about 12.5 hours filing them. Upwards of $10 billion a year is spent in tax preparation.
Isn’t there a better way?
“Better” is a subjective phrase when it comes to taxes. Other countries certainly have more simplified systems. In the Netherlands, the IRS fills out the tax form for its citizens. The Dutch simply need to go online, review the information provided and amend as necessary. In Japan, the system is more of a ‘no contest’ arrangement. Citizens receive a postcard in the mail that estimates their income for the year, how much they paid in taxes and what (if any) is owed / refunded. If everything looks right (which it does to about 85% of Japanese citizens), you do nothing and your refund check arrives in a few months.
Of course, there are obvious pros and cons to these arrangements, the least of which is not how much faith to put in your government. Neither of these (or any other) arrangements have done a great job of buttoning up security breaches and fraudulent filings, though arguably a simpler system would leave less room for crooks to intervene.
What’s with the title of this blog?
Historically, the US tax system gets a major overhaul every 32 years. It seems it takes about that long for the code to get so convoluted and expansive that it requires major reform. The tax code was overhauled in 1922, 1954, 1986...if history is any indicator, 2018 may be the year we see it happen again.
Both major political parties agree reform is needed, but agreements on how are of course limited. A major proposal is to comb through and remove some of the corporation-specific loopholes and exemptions. There are hundreds of these in the tax code that total about $1 trillion in lost revenue each year. When the code was revamped in 1986, removing these credits lower the top rate from 70% to 28% with no loss in revenue.
What is in Trump’s most recent tax proposal?
Here are the brass tacks:
- Collapse the tax brackets from seven to three, with rates of 12%, 25% and 35%.
- Doubling the standard deduction (from $12,000 to $24,000).
- Provide a $500 tax credit for all non-child dependents (e.g. elderly).
- Increase the child tax credit from $1,000 to an unspecified amount.
- Reducing the maximum small-business tax rate from 39.6% to 25%.
- Reduce the corporate tax from 35% to 20%.
- Remove taxation from overseas profits of US companies.
Of course, this will change over time as Congress members on both sides of the aisle get their hands on it. As your team of Certified Financial Planners™, our job expands beyond wealth management and retirement planning. We work to keep you informed and educate you on both the past, and what lies ahead. We’ll keep you in the know as more comes to light.
 Kelley Phillips Erb, Report: Americans Spend More Than 8.9 Billion Hours Each Year on Tax Compliance (Forbes: 6.20.2016), https://www.forbes.com/sites/kellyphillipserb/2016/06/20/report-americans-spend-more-than-8-9-billion-hours-each-year-on-tax-compliance/#248672593456.
 Knowledge@Wharton.com, Time for a Tax Overhaul: What the U.S. Can Learn from Other Countries (Wharton University of Pennsylvania: 09.08.2017), http://knowledge.wharton.upenn.edu/article/why-a-tax-overhaul-is-coming-soon/.