The 16th Amendment
There have been numerous changes made to the tax code since the 16th Amendment to the Constitution was adopted in 1913. This Amendment granted the Federal government the ability to levy a tax on income. The initial income tax rate was 1% on the first $20,000 of income. Congress immediately started tweaking the income tax system by adjusting bracket levels and assessing new taxes. A series of 17 Internal Revenue Acts between 1913 and 1939 forced the government to consolidate these numerous Acts into a set of tax rules that became the first formal Internal Revenue Code of 1939.
Tax Reform in 1954 Simplifies the Code
Congress continued to add layers of rules and new laws to the Code so that by 1954, a major cleanup of the Code, which had again become too complex, was needed. The Internal Revenue Code of 1954 became the first true tax reform to simplify the numerous complex layers of taxes and deductions. The top tax bracket was now 91% but there was a wide range of deductions and shelters to shield taxpayers from paying at that level.
Enter the AMT
This new Code became the primary framework of the income tax system, but Congress continued to tweak the Code adding more and more complexity. Tax deductions and shelters were so expansive that some high-income taxpayers paid little or no income tax. The Tax Reform Act of 1969 was passed when Treasury Secretary Joseph Barr discovered that 155 high-income households had not paid a dime of federal income taxes. These taxpayers had taken advantage of so many tax benefits and deductions that they had reduced their tax liability to zero. The Alternative Minimum Tax (AMT) was created to close the loopholes.
The AMT is a supplemental income tax that, some feel, creates yet another level of complexity. The AMT is imposed at a nearly flat rate on an adjusted amount of taxable income above a certain threshold. Taxpayers are required to compute their tax liability two different ways and pay the higher amount.
Tax Reform Act of 1986
The Tax Reform Act of 1986 was passed to eliminate the years of complexity that had built up since the last tax reform in 1954. This Act eliminated many of the deductions in exchange for a simplified tax code and reduced tax rates and reduced the number of brackets down to two – 15% and 28%.
More Complexity Added
Our tax code has been growing in complexity ever since. The IRS website says it takes the average taxpayer 16 hours to fill out Form 1040 (70% of all tax returns). They claim it takes 4 hours to complete the 1040 EZ. The Tax Foundation says it takes the country 8.9 billion hours and cost $409 billion just to do their taxes. About 80% of individuals hire someone or buy tax software to file their taxes even though 64% of taxpayers don’t owe anything. Close to 67% of low income filers pay to have their taxes prepared. There are six definitions of a child, more than a dozen educational credits and 16 different types of tax-favored savings plans. The 2015 National Taxpayer Advocate report estimated each year small businesses spend approximately 2.5 billion hours preparing tax returns or otherwise responding to IRS inquiries about the preparation of their returns, the equivalent of 1.25 million full-time jobs. The report estimated small businesses pay $16 billion to help prepare their tax returns. In my opinion tax reform is long overdue.
What President Trump Proposes
What President Trump has proposed is not actually tax reform in the classic definition of simplification. The President wants to reduce the current seven tax brackets down to three – 12%, 25% and 33%. The current 3-tier capital gains tax structure, with 0%, 15%, and 20% rates, would remain in place (and continue to apply to qualified dividends as well). Capital gains brackets would match the three income brackets. I believe these proposals are a step in the right direction towards true tax reform. However, it’s the President’s treatment of deductions that moves his position away from simplification.
Not So Simple
President Trump would keep all itemized deductions. He would add to it a more aggressive phase out of many deductions at higher income levels. He wants to consolidate the standard deduction and personal exemptions into a single, larger standard deduction of $15,000 for individuals, and $30,000 for married couples. The President has also proposed several new tax breaks that would apply specifically for families supporting dependents – either children or adult parents.
- An above-the-line deduction for child care expenses.
- A similar above-the-line deduction for “elder care” expenses.
- A new Dependent Care Savings Account (DCSA).
- Low-income households eligible for the EITC would get up to a 50% match.
Keeping the current complexity of itemized deductions, the new above-the-line deductions, and new tax-preferenced accounts, would, in my opinion, ultimately maintain or even add to the complexity of the tax code.
The “Better Way for Tax Reform”
The “Better Way for Tax Reform” proposal from House Republicans aims to truly simplify the tax system. The goal of the reform proposal is to simplify the tax code so that many individual tax returns could be filed on a postcard. The Republicans hold the White House and majorities in both houses of Congress. There are some similarities about how to reform the tax code but disagreements remain. It’s important to note the Tax Reform Act of 1986 took two years to pass. American taxpayers are in desperate need of tax reform. Maybe 2017 will be the year!