Taxes! Don’t know about you, but just seeing the word “taxes” can bring full-on panic. This week, President Obama announced part of his new tax code plan. I decided to get some help understanding it all from tax professor Annette Nellen, director of the Master’s taxation program at San Jose State University.
Hope this helps! Here’s Annette…
When the term “tax code” is used, what does it refer to? Does it only refer to our yearly income tax forms?
We often hear politicians refer to the “tax code.” This reference is to the “Internal Revenue Code” which is the statute for federal tax rules on the income, excise, employment, and estate and gift taxes. When Congress makes a change to the tax law, they are changing the “Code.”
The other two branches of government also provide part of the tax law. The administrative branch via the Treasury Department and IRS provide regulations interpreting the tax code as well as rulings and the judiciary branch issues court decisions that resolve disputes between the government and taxpayers on the interpretation of the law or on a factual dispute.
Sometimes people, including members of Congress and the press, refer improperly to the “IRS Code” or say that the IRS denies a deduction. This tends to shift blame for things we don’t like with the tax system or the law to the IRS when it is Congress that writes the tax statutes.
Can you explain the tax code announcement President Obama made earlier this week? What are the overall goals of the administration? How will these changes affect the everyday person? And do you think they’re needed?
On May 4, President Obama unveiled part of the tax plan that he eluded to both in his campaign and in the budget framework he released in February. The May 4 release was focused on international tax reform which he hopes will reduce the ability to shelter income in foreign bank accounts (a “tax haven” problem) and to discourage companies from creating jobs overseas. The tax haven issue is longstanding – there have been hearings and reports on it dating back 50 years. As a senator, Mr. Obama had a proposal to reduce this type of tax sheltering activity. Part of the problem is enforcement – finding people who put money in foreign banks and do not report it on their U.S. tax returns. President Obama’s tax proposal calls for hiring 800 IRS auditors for international enforcement.
The proposal to discourage U.S. companies from creating jobs outside of the U.S. will probably be difficult to draft and enact. There are many reasons for these global companies to have workers outside of the U.S. including that they have lots of customers outside of the U.S. I hope this discussion will move towards modernizing our business tax system to bring it to the 21st century ways of doing business that recognize that the U.S. is no longer as big of a player in the global economy as it was decades ago when the tax rules were written. Also, other countries have lowered their corporate tax rate and typically only tax income earned within their borders. The U.S. generally taxes income earned anywhere in the world. These differences in tax rules can make it difficult for U.S. companies to compete in the global marketplace.
These proposals will affect anyone with foreign investments and business activities. If the tax haven proposal can bring in tax dollars that today are not collected because of improper sheltering, that helps everyone. The business tax proposal also affects everyone indirectly because the ability of U.S. companies to effectively compete in the global market is important to the U.S. economy.
Are there any particular tax code changes that will affect and/or benefit particular women in the U.S.? Working-class? Immigrant? Single moms?
President Obama’s tax proposals aim to prevent tax increases for 95% of individuals. That is a very broad benefit particularly when we are facing trillion dollar deficits.
It is not easy to look at the entire tax system and proposals for change to determine the direct and indirect impact to people. Our federal tax system includes provisions that benefit low-income workers as well as high-income investors. There are rules that benefit people with home mortgages, compensation packages that include fringe benefits, and people who do well in the stock market. The complexity of the tax system makes it challenging to see how the numerous favorable rules for fringe benefits, certain energy-saving devices, charitable contributions, employer-provided health insurance and others affect people’s tax bills.
A tax system tends to be more efficient and simple if it has few deductions, exclusions and credits. With fewer tax breaks, the tax rates can be lower which also provides a benefit of reducing the desire to engage in tax planning to further reduce one’s taxes. A system with fewer special rules also increases the perception of fairness and respect for the system because people are not thinking that someone else is getting more tax breaks than they are.
In addition to the federal tax system and proposed changes, people should also be looking at state and local taxes. Almost all states are facing budget shortfalls and have enacted or are considering tax increases. These tax increases tend to be the easy ones of raising rates rather than removing or reducing deductions. Sometimes these types of changes can have a more burdensome impact on low-income individuals. For example, to help address a budget shortfall, California recently increased its sales tax rate by 1 percentage point. In many places in the state, the rate is now 9.25%. This is the highest sales tax rate among the states. California’s sales tax system is out-of-date in that it primarily applies to tangible personal property (other than grocery store food). It does not apply to digital downloads, entertainment and most services. Thus, “Laura” who buys laundry detergent and rents a DVD pays sales tax. In contrast, “Hannah” who buys music for an mp3 player, a $300 concert ticket and has her clothes dry cleaned pays no sales tax on these items. Adding to the unfairness is the fact that Laura probably has lower income than Hannah.
What was your calling to tax code work? How did you get involved in the field?
I started my tax career at the IRS many years ago. I also worked at a large certified public accounting firm prior to going into full-time teaching. As a professor, I have moved from primarily focusing on the technical nature of the law (how to apply it) to also spending a lot of time on the policy aspects of the law (how to critique and design tax systems). I enjoy researching, writing and speaking about tax policy and tax reform at the federal and state levels. I hope my work is beneficial to tax practitioners, policymakers and anyone interested in tax policy to help them understand our very complicated tax system and its implications for our economy and society. I like to look for ways that tax systems can better meet the principles of good tax policy such as by being simpler and fairer.
For the past two years, I have been blogging at 21st Century Taxation to discuss issues and ideas on how to modernize our tax systems to have them better address today’s ways of living and doing business. I also write a lot of short articles and longer analysis reports that I have posted at http://www.cob.sjsu.edu/nellen_a/TaxReform/21st_century_taxation.htm.
What did you think about the “Tea Parties” that took place on and around income tax filing day last month?
While called tea parties, these protests seemed to be voicing concern over government spending (rather than particular taxes per se) and took place on April 15 rather than the historical date of December 16 (1773). I think it is good to see people getting involved in looking at what their elected representatives are doing. I hope people will also get details about the spending, who and what it is benefiting and write to their representatives to express specific concerns or new ideas.
Everyone gets benefits from the government in some form. It might be public schooling, roads, police and fire protection, government subsidies for one’s home mortgage or health insurance coverage, energy credits, and more. Many people are benefiting from the stimulus money in that it is helping to create jobs, provide tax credits or stimulus payments to about 95% of individuals, and reducing state tax hikes.
What specific spending do people want to see cut? The answer should include not only direct government spending, but also the spending that exists in the tax law. Special deductions, exclusions and credits, such as for alternative fuel vehicles or a home mortgage, are a form of government spending. For example, the government can subsidize a person’s home mortgage by writing them a check or by giving them a reduced tax bill – both are spending. What specifically are people willing to cut? I think people must include on that list not only spending that benefits others, but spending that benefits them as well. That is where the task gets challenging.
I know every year, it never fails, I dread filing my taxes. What should we keep in mind to help making the fax filing process easier?
No doubt, our federal and state income tax systems are very complicated. The complications exist not only for high-income individuals and businesses, but also for low-income workers claiming the earned income tax credit. Ideally, the system needs to be simplified, but it is not an easy task. Simplification can be achieved by reducing the vast number of special deductions and credits and lowering the tax rate. But, this is a political challenge because voters typically don’t want to see a credit for solar panels or child care, for example, disappear. Until more voters truly want a simpler system and demand it of their elected officials, we will not see it. So, more people will hire a preparer or purchase software, which does make filing simpler, but comes at a higher cost and can mask the complexity.
About half of individuals could have the government prepare their return because the government knows their income and how many dependents they have (from Forms W-2, 1099 and W-4). Also, most individuals claim the standard deduction rather than itemize. With a few simplifications, such as higher standard deduction and elimination of a tax break for child care expenses (information the government does not have), the IRS can file the return for you. Unfortunately, many people do not trust the government to do this. I hope we can move past this to make the system simpler for many individuals. Several countries use this type of filing system today.
Is there anything you would like to add?
There is a lot of misinformation on the Internet and elsewhere about taxes. I encourage people to find ways to better understand taxation by questioning statements they may hear and taking time to understand their own taxes (such as by reading publications provided at the IRS and state tax agency websites). Our tax systems can be improved, but I think politicians need to hear from taxpayers that this is truly what they want.
Please visit my 21st Century Taxation website and blog. Send me a tax policy question, I’ll be glad to answer it. Or post a comment with an idea for how to improve the tax system.