A Seven- Step Program to Fix the U.S. Tax System

This column, in slightly different format, originally appeared in The San Francisco Examiner Newspaper November 16, 1997.

Copyright 1995-7 Robert L. Sommers, all rights reserved.

A Seven-Step Program to Fix the U.S. Tax System

As the Senate hearings have televised to the nation, IRS can be arrogant, abusive and a law-breaker when dealing with the taxpaying public. There is, however, a two-fold problem with the current system: (1) an incomprehensible tax code -- thanks to Congress; and (2) a dysfunctional IRS bureaucracy that has been given carte blanche to interpret and apply the code, and then collect taxes. Here’s a 7-step proposal to fix this system:


Adopt a Modified Flat Tax

My proposal (formulated after analyzing the major radical tax reform concepts), is a "modified flat tax," which will simply the current tax system without significantly changing the present tax burden. It retains our current progressive tax system (those with higher incomes pay a greater percentage), yet combines elements of a flat tax.

Step One: All income and gains taxable under the current system remain taxable. Municipal bond interest continues its tax-free status. Capital gains and capital losses would be netted, but net gains would be taxed as ordinary income. Capital losses would be carried forward as under current law.

Analysis: This approach does not favor one type of income over another. It eliminates: (1) all current adjusted gross income ("AGI") limitations and phase-outs; (2) distinctions between types of income (passive activities, investment activities); (3) tax credits and deductions targeted to certain AGI levels; (4) the dreaded alternative minimum tax; and (5) capital gains tax complications. Either everyone gets the same tax break or no one does.

Step Two: Deductions for mortgage interest, charitable gifts, alimony payments and state income taxes remain unchanged.

Analysis: These deductions are necessary to avoid serious economic disruption. Also, retaining tax-free treatment for municipal bond interest prevents a potentially cataclysmic disturbance in this market.

Step Three: Determine the percentage of tax currently paid by taxpayers. In 1995, individual income taxes amounted to $590 billion. It is generally reported that 5% of the returns produced 50% of tax revenues, and the top 1% generated 30% of tax revenues. These ratios should be maintained to ensure that taxpayers generally pay the same amount of tax under the new system.

Use three tax rates to raise the same amount of revenue without significantly raising or lowering the tax burden for any segment of taxpayers. For instance: Exclude tax for families with incomes of less than $20,000; use a 24% tax for taxable incomes under $70,000; 28% on taxable income between $70,000-$250,000; and 32% on taxable income over $200,000.

Make appropriate adjustments for tax status (married filing jointly or separately, single, head of household) and dependency exemptions, then adjust the tax rates and brackets to raise the same revenue as our current system.


Four Steps To Improving the Tax Collections System

Step One: State law protections regarding homestead exemption for residences, limitations on wage garnishments and state exemptions as to property should similarly apply to IRS.

Also, with any garnishment or levy (collectively "levy"), taxpayers should be notified that they may contact the Taxpayer Advocate ("TA") for immediate assistance. A publication describing the TA’s services, contact number and necessary forms should be provided. Once the TA has been engaged, it would be required, within two business days, conclude that the levy will not cause hardship to the taxpayer; otherwise, the levy would be released. Hardship would be presumed if the taxpayer’s necessary living expenses for 30 days would be significantly diminished by the levy.

Step Two: The maximum levy percentage under state law should apply to all federal and state taxing authorities. For instance, if the law permits a maximum of 25% on wage garnishments, then IRS and state tax authorities should be limited to that amount. Also, IRS and state tax authorities should share in the proceeds on a pro-rata basis. For instance, if a wage earner who owes $4,000 to the IRS and $1,000 to the state receives $400, $100 of which is subject to garnishment, the IRS and state tax collectors would share as follows: $80 to IRS (4,000/5,000 X100) and $20 to the state.

Step Three: The current tax liability on joint returns is an outrage. By signing a joint return, a couple might save $1,000 in taxes, but each spouse automatically becomes liable for an unlimited tax increase, even if the increase was caused by the other spouse! The solution: Calculate the innocent spouse’s share as if he or she filed as married filing separately and compare this result to the tax break received by filing jointly. The innocent spouse’s tax liability should not exceed twice the savings obtained by filing a joint return. Also, unlike current law, earnings of one spouse should never be levied to pay the tax debts of the other spouse.

Step Four: Whenever there is a collection dispute, the TA should hold a hearing in which the IRS and taxpayer present their sides. Decisions of the TA should be published and IRS reprimands should be made public. The TA must be separate and independent from the IRS, with appointed civilian oversight.


Conclusion

Fixing the tax code and collection procedures should be a top priority in Congress. These seven proposals would go a long way to improving the system, without unduly benefiting or burdening any particular segment of the taxpaying public.




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