Keith Baker’s article, below, again starts the discussion on how tax law from 1954 to 1986 to now trips over itself.
The few academics who understand tax law excludes, unfortunately, almost every elected official. Thus, how can meaningful tax reform be made law if the lawmakers have no clue about tax laws?
Keith B. Baker, CPA, Law Offices of Keith B. Baker, Ltd, Skokie
847-933-0200 | Email Keith B. Baker
Fixing Our Broken Tax Code?
I read the Executive Summary of the Tax Reform Act of 2014: Fixing Our Broken Tax Code So That It Works for American Families and Job Creators (TRA 2014), published by the U.S. House Ways and Means Committee. Well, golly, who isn’t for that?
Just when I thought that the entire federal Tax Code would be fixed by the current members of the U.S. House of Representatives, I began to read the Executive Summary. It did not take long for my bubble to be burst. In the first several pages, they harkened back to October 22, 1986, when President Reagan signed the Tax Reform Act of 1986 (TRA 86), Pub.L. 99-514, 100 Stat. 2085, and they proclaimed that TRA 86 simplified the Federal Tax Code. The Summary goes on to say that “evildoing” legislators have since violated the spirit of TRA 86 by making the federal income tax system complex. They conclude by heralding the Tax Reform Act of 2014 as the vehicle for righting the wrongs that occurred post-TRA 8. It is as though TRA 86 was the embodiment of Reagan’s “It’s morning in America again” catch phrase and that we had since lost our way.
TRA 86 Simplification — Fact or Fiction.
Let’s take a brief journey to 30 years ago. In 1985, the Reagan administration promoted a bill called “Tax Reform for Fairness, Simplicity, and Economic Growth” which ultimately became law as TRA 86. Who isn’t for fairness, simplicity and economic growth?
By the time that the federal legislators were finished making things “fair,” “simple,” and aimed at promoting “economic growth,” the enacted legislation retained no vestige of “simple” — and as to “fairness” and “economic growth” — those concepts were in the eyes of the beholders. Below are listed a few of the many consequences of TRA 86:
- The words “simplicity,” “fairness,” and “economic growth” were dropped from the name of the Act.
- TRA 86 gave us the most sweeping set of changes provided in a single Act since the federal Tax Code was created.
- The changes were so significant that the Internal Revenue Code of 1954 was renamed the Internal Revenue Code of 1986 (the name which it retains today).
- The federal income tax laws were expanded so much that the CCH print version of the Internal Revenue Code went from a single volume to a two-volume set.
- TRA 86 caused a huge increase in the billable hours of CPAs and tax attorneys — an increase that continues to benefit tax professionals today. (We certainly got growth there!)
- The tax shelter industry was fueled in large part by the Economic Recovery Tax Act of 1981 (ERTA), Pub.L. 97-34, 95 Stat. 172. ERTA was pushed by Reagan to stimulate economic growth. (For example, ERTA allowed dramatically larger and faster deductions for depreciation which promoted real estate development — and all the jobs related thereto. However, the tax incentives of ERTA soon became characterized as “abusive loopholes” closed by the “passive loss” rules of TRA 86 and the concept of “substantial economic effect” of 26 U.S.C. §704(b). Every taxpayer who owns or invests in real estate that is rented must contend with the passive loss rules created by TRA 86. This makes things more complex. It is considered by many to be unfair in general but even more so since it was applied retroactively to taxpayers who invested prior to the enactment of TRA 86.)
- The alternative minimum tax (AMT) was expanded by TRA 86 to include the types of deductions claimed by average Americans. (This has resulted in an ever-increasing number of Americans being ensnared by AMT. In brief, taxpayers must prepare their federal income tax returns two ways — once under the “regular tax” method and again under the AMT method. Taxpayers must then pay based on the higher of the two methods. This makes things more complex and is considered by many to be an unfair “stealth tax.”)
- The classification of interest deductions became more complicated as a result of TRA 86. (Under TRA 86, interest had to be classified into one of three categories and, in some cases, subdivided even further.)
- Mortgage interest deductions were dealt a double blow by TRA 86. (As a result of TRA 86 taxpayers must determine and track a moving target called “original acquisition debt” and separately, “home equity debt”. TRA 86 also capped the amount of mortgage interest paid that can be deducted based on the principal owed. This makes things more complex and is considered by many to be unfair.)
Why Are the Federal Income Tax Laws So Complex?
The vast majority of Americans agree that the federal Tax Code is complex. Why is the federal income tax system so complex?
Many have speculated as to how the Code could have been written with such complexity. Was it written through thoughtful drafting by the U.S. House and Senate or by an infinite number of monkeys using an infinite number of typewriters?
To be clear, I am not suggesting that our federal legislators are monkeys or advocating the mistreatment of animals. Rather, I am applying the “infinite monkey theorem” — which is about mathematics and probability — to the writing of the Tax Code. According to Princeton University’s definition, the reference to monkeys is “a metaphor for an abstract device that produces a random sequence of letters ad infinitum.”
Humor aside, the principal reason for the complexity of our federal income tax system is that it is used as a tool by federal legislators (1) to effectuate public policy, economic policy, religious and moral policy; and (2) for political purposes. The system is designed to encourage some behaviors and discourage other behaviors. This guides
(1) what is subject to tax and at what rate;
(2) what is deductible, when it is deductible, by whom it is deductible;
(3) what tax credits exist, and
(4) who can claim a credit and for what activities.
In the right hands these are wonderful tools to benefit Americans.
Conclusion.
The same federal legislative body that proclaimed in 1986 that TRA 86 would create simplicity, fairness and growth nowsays:
TRA 86 really did simplify the Federal Tax system.
We somehow “lost our way” after the simplification of TRA 86.
TRA 2014 will right the wrongs that the “terrible” post-TRA 86 tax legislation caused.
The truth is that TRA 86 was itself one of the great causes of complexity. Stating that any tax legislation will do for us what TRA 86 did for us should serve as a warning of more complexity, not as the herald of a return to simpler times.
My son is a university senior majoring in systems engineering. He is learning how complex systems are interconnected and how to effectuate improvements. Perhaps the greatest challenge facing systems engineers is our system of federal income taxation. The motto of his university is “leges sine moribus vanae” — “laws without morals [are] useless.” Perhaps, when you hear federal legislators proclaiming tax legislation that will “simplify” the federal income tax laws, another phrase will come to mind, one written by Virgil, circa 20 B.C., referring to the Trojan War: “timeo Danaos et dona ferentes” — “beware of Greeks bearing gifts.”
Copyright © Keith B. Baker, 2014