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November 2, 2011

Some topics keep coming back, flat tax is an example.

Training at the Internal Revenue Service started before we were permitted to audit tax returns.  One of the first subjects discussed was the fairness of the Internal Revenue Code. 
Generally our studies of a code section began with the purpose of the tax provision.  Many provisions were attempts to reflect a persons ability to pay taxes.  For example, if medical expenses or casualty expenses were higher than a stated threshold, the taxpayer was thought to have less ability to pay taxes than those with lower medical or casualty expenses.  
The same was true for businesses.  The total income of a business was reduced by ordinary and necessary business expenses.  A business with lower profits had less ability to pay taxes than businesses with high profits.
Sections of the Internal Revenue Code also contained provisions to encourage certainactivities.  Charitable contributions and home mortgage expenses are examples of activities directed toward individuals.  Oil and gas intangible drilling costs, depletion allowances and expensing of plant and equipment are examples aimed at businesses. 
We were told that if we could suggest how to make the tax laws fairer or simpler we would be rewarded.  We had a lengthy discussion as to whose perspective would be used to determine fairness.  This reminded me of an economic course I took in college.  We looked at various industries that wanted regulation and taxation to be reduced.  Each industry we looked at were granted exclusive rights and/or tax deductions that they were not willing to give up.  Those regulations and tax deductions were considered a separate topic that were not to be part of the discussion.    
There were discussions in the 60’s about why deductions, exemptions and exclusions should be eliminated.  I believe the primary author was a professor Surey from Harvard.  His argument was that these amounted to tax deduction that were not reflected in the budget.  This made it difficult to track and quantify the expenditures (lost revenue).  He suggested that direct payments should be made directly to taxpayers.  This would allow an analysis of the cost and benefits of the expenditures. 
When a flat tax was was discussed in the past, business were not sure how their income would be measured.  Could they reduce their income by all the deductions they were used to taking?  Would the timing of when they recognize income and deductions be changed?
Not-for -profit organizations were concerned that the amount they collected would drop.  How would the housing industry be affected if home mortgage and real estate taxes were not deductible.  There were discussion about the loss of the progressive nature of our income tax system.  Should the amount of tax paid or the percentage of income be used to determine fairness?  Would gross income, net income, adjusted gross income, taxable income or some other measurement be used?
How would we transition to the new system?  What should happen to unused operating losses and capital losses?  How should amounts in qualified retirement plans, Individual retirement accounts (IRAs), Roth IRAs, etc. be handled?
If it was difficult to deal with those types of questions then.  Think about how much more difficult it would be in the current political climate.  
Another issue confusingthe discussions relates to the comparison to our system to those of other countries.  Many countries have a Value Added Tax (VAT)   in addition to an income tax.  The VAT tax is similar to a national sales tax.  A tax is applied at each incremental step in the production of a product.  When comparing our rates to the other countries, why aren’t their VAT considered?
The above are a small sampling of questions that have come back form the past.  It would take volumes to discuss and try to resolve these issues.   Hopefully I have given you something to think about as you listen to the current discussion about our tax laws.  I would not be surprised if some have stopped listening and thinking about these issues.

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