U.S. needs new tax code

Karl Hailperin

With Tax Day approaching, it is inevitable for the nation’s talking heads to not just focus on tax matters, but to focus on the matter of how much we pay. Should the government increase taxes to close the deficit and/or to finance additional spending projects? Is the amount it takes in already too much? What amount of money should be paid by the various income groups? These matters of “how much” are the sorts of questions that pundits and columnists give their opinions about, and it completely ignores a question of equal importance: how do we raise the money?
It is important not just that the federal government raise enough money to finance its proper functions. It should also raise that money in manner that does not impose undue costs above and beyond how much money people send to the IRS. By that standard, the way the federal income tax is currently structured is a complete failure. It is not just that it is pain to comply with, although it certainly has that quality in spades. It also causes damage in the form of pointlessly impairing economic health.
Our tax code’s countless special favors warp incentives, encouraging individuals and businesses to engage in behavior that, while advantageous individually, is a misallocation of resources from the perspective of the economy as a whole and leaves society poorer as a result. One of the worst offenders is the tax code’s treatment of savings and debt. Various provisions in the tax code create a bias in favor of debt. The system encourages excessive borrowing and leverage while punishing the savings, investment and capital formation that help drive economic growth.
All of the quirks in the system give rise to an industry of accountants and tax lawyers employed to help people take full advantage of them – an industry that does nothing but help shift money from one party to another. Work devoted to redistribution could be, but is not, devoted to productive work. The people employed to use their ingenuity to make the most of the tax code are not pursuing lines of work that produce new ideas, goods and services that improve our lives.
The tax lobbyists that descend on Washington on behalf of their rent-seeking clients are even worse. Their behavior not only imposes the same costs of labor devoted to transferring wealth rather than creating it, but by encouraging Congress to adopt further distortionary tax changes than they might otherwise, they increase the drag on the economy created by the favors in the tax code. Their work is aided by the fact that since the tax code is already so complex, additional changes are easy to pass with little notice from the public.
While the tax code has been altered many times in recent history, few of the changes address its real, structural problems. They tend to involve tweaking a credit here or changing a marginal rate there. Since theses changes tend to involve adding new provisions to the code, they usually make the problem worse instead of better.
The solution is not for Congress to tinker with the income tax code. The solution is to take the code, shove it through a paper shredder and build a new code from scratch.