Eliminate the IRS?

I'm sorry, but talk of eliminating the income tax is just silly. I work with tax law for a living, and I wish that conservatives would think about these things before saying them out loud. It makes our side look bad.

1. How will switching from an income tax to a sales tax or VAT eliminate the IRS? No matter what kind of tax we use to fund the federal government, some federal agency must collect it. Most people won't just mail in their checks out of a sense of civic duty.

2. Why do you think that a sales tax or VAT will be simpler than an income tax? It may be simpler for consumers, but it will still be quite complicated for businesses. There are lots of difficult questions to ask about sales taxes, just as there are about income taxes.

We don't have to speculate about the complexity inherent in sales taxes---or about anything else about sales taxes---because they're already so common at the state level. And the VAT is already in use in Europe. Skim through a real sales tax and tell me how simple and economically pure it looks to you: http://www.capitol.state.tx.us/statutes/docs/TX/content/htm/tx.002.00.000151.00.htm#151.001.00

3. The main point of the VAT seems to be to conceal from the citizenry the amount of tax they're paying. The VAT builds the tax into the prices that consumers/voters pay, so they blame merchants for high prices rather than blaming the government for high taxes. (We do the same thing with gasoline in this country.) At least with a traditional sales tax you can see the amount of tax you're paying, although it still seems like you're paying it to the merchant rather than the government.

Conservatives normally hate this kind of stealth taxation with payroll taxes---only part of which you really see even if you look at your payroll stub. (Ask a self-employed person what those taxes really look like. They pay the full amount on their 1040s.) Repealing payroll taxes to enact a VAT would be going out of the frying pan and into the fire in terms of political accountability for tax levels.

4. Sales taxes or VATs breed corruption, because it's never clear even in theory which goods and services should be subject to the tax. Politically, they're like tariffs: Every industry has a powerful incentive to lobby the legislature and try to get an exemption or reduced rate, or to keep an exemption in place. The Texas legislature goes through these kinds of battles every session.

5. A fair tax system tries not to warp the economy. Because they don't apply to everything, sales taxes or VATs warp economic activity in at least two ways:

5.1. First, they do this by rewarding the purchase of non-taxed services instead of taxed services and tangible goods. The sales tax is very 19th century in its thinking: It starts with the idea that tangible goods represent economic activity, so if you tax the sale of tangible goods then you've taxed the entire economy fairly. But in the 21st century we have a service economy, with tangible goods rapidly decreasing in economic importance. So a sales tax on tangible goods only would pummel a relatively small portion of the economy. But expanding a sales tax to include services raises a dense thicket of practical and theoretical problems. To my knowledge, nobody has ever seriously proposed taxing every type of service. If you really tried to make one, I think you would end up with an income tax.

5.2. Second, sales taxes reward consumers who purchase goods from outside of the taxing jurisdiction. The consumers technically aren't free from the tax, but it's impossible to collect as a practical matter. Right now the states with big sales taxes are having trouble collecting from people who buy from out of state---this is a big engine behind internet sales and catalog sales. A national sales tax would have the same problem on a larger scale: Buy from a US merchant and you have to pay the tax, but by from a foreign merchant and maybe you don't.

6. Would this national sales tax extend to precisely the same goods and services that current state sales taxes do? It couldn't, of course, because different states tax different goods and services, and extend different exemptions. Trying to collect two inconsistent sales taxes at the same would be unworkable. So a national sales tax would somehow have to force all the states with sales taxes to get in line and charge their sales taxes on top of the federal sales tax in a harmonized system. And conservatives want this?

The states already do something like this in income taxes: Most (probably all) states don't have their own rules for calculating taxable income. They rely on the federal rules and just tax that figure. I suspect that historically the federal income tax came first, which was what made that possible. Also, it's easier to talk about a consistent definition of income, because it's a coherent economic idea. It's an internally consistent idea that has meaning independent of any rules defining it. By contrast, phrases like "taxable goods" and "taxable services" have no inherent meaning apart from whatever political deal the legislature settled on most recently.

I hate to post at such length about this, because the kind of legislation you're talking about is strictly about rousing conservative voters who hate the IRS. It will never become law. The sales tax is an old idea designed for an old-fashioned economy. Income taxes are much better, in that they have fewer jurisdiction problems and they're much harder for political interests to corrupt. No serious person who knows much about taxation would want to go backwards from an income tax to a sales tax. Talking as if doing so is possible or wise just lowers conservative credibility on more serious issues.

I'm sympathetic to conservatives who want income tax rates to be lower and less progressive. But you don't need to burn down the system to accomplish those goals. Somebody has to collect the taxes to pay the Marines, and an income tax is the fairest kind of tax we know how to collect.

As for complexity, most of the detail in the current federal income tax has nothing whatsoever to do with the taxes that most individuals pay. The complexity is there mostly because people want a very fair and predictable tax system, which means lots of little rules for obscure situations that don't fit under the general rules.

A fair tax system will be as complex as the economy it taxes. No matter kind of tax you're talking about, if you think that we can fairly tax the largest economy on Earth with some stripped-down pamphlet of a rule book, then you don't know much about taxation.

BB: Hm, very interesting perspective, can I post it on the front page?

However, California definitely has its own income tax system, becuase I have to fill out all the forms every year.

Also, what's wrong with a sales tax that just taxes everything? That doesn't sound hard to implement at all. I don't like VATs either, but sales taxes are hardly "stealth". Many states are funded solely by sales taxes (Tennessee) and they tend to have much more consistent revenue streams year-by-year.

Maybe food and other "essentials" could be exempted, that'd be fine. Mortgage interest and charitable contributions would probably have to stay tax-free. Other that those, I don't see much complexity. Sure, some services would be hard to tax, but there are already tons of ways to shelter income from taxation. Plus, many people in corporate and take income in other countries, &c.

Anyway, maybe I'm just disappointed that you don't like the idea.

I dont need to read all of BB's points to know that he's right -- this sounds like a poorly timed April Fools Joke.

What, do you think the CPA's and Tax & Estate Lawyers who would lose thier jobs don't have enough clout to scuttle the whole plan? Surely the do...

Ben, What are your thoughts on flat tax proposals...like the one Dick Armey used to push (17% flat rate for everyone making over $38,000)? I know the IRS wouldn't go away and you'd still need accountants. But it seems like it would be easier for the common man to understand. Of course, the politicians wouldn't like it because it would be the end of their "vote-for-me-and-I'll-give-your-company-a-tax-break" games.

Ben, no offense, but one need not look beyond your first paragraph to understand why you disgree with abolishing the current tax system:

"I'm sorry, but talk of eliminating the income tax is just silly. I work with tax law for a living..."

Not that I don't understand. I would be nervous at the thought of my career dissapearing, too.

MW: "California definitely has its own income tax system, becuase I have to fill out all the forms every year."

Yes, it collects the taxes separately, but it doesn't have its own idiosyncratic system for calculating income. That's the hard part. On line 12b of your California income tax return you enter your Adjusted Gross Income from your federal tax return. That’s how they incorporate a vast body of federal tax law into their state income tax.

"what's wrong with a sales tax that just taxes everything?"

The problem comes in services. Suppose that we make all services taxable: You pay sales tax to your doctor, and your lawyer, and your barber, and your computer guy. Let’s suppose that I call in a computer guy to fix my computer. He charges me for his service, then he charges me sales tax on that amount. Later that day, I’m complaining to to a friend of mine about all the tax I had to pay for getting my computer fixed. This friend of mine works at a larger law firm, and he says that they don’t pay any sales tax to their computer guy. Why? Because he’s a law firm employee, not an independent contractor. As an employee he isn’t considered to be selling specific services to his employer, so he isn’t under the sales tax.

It shouldn’t hard to see where this system will take us: If you have to pay sales tax on services by independent contractors but not on services by employees, then the tax structure will drive people to stop using ICs and start using more employees. The tax system has warped the economy, which is the thing we try to avoid in tax law. So we would need a new tax that applies the sales tax rate to wages paid to employees, all of whom are in effect selling their services to their employers. And now we're right back to the employment tax / self-employment tax system that we tried to get away from.

"Maybe food and other "essentials" could be exempted, that'd be fine."

Already you've opened the door for pressure groups to have their products declared essential. It's the same sort of argument the steel industry makes on tariffs: “We're vital to national security, so keep the foreigners out with high taxes or we’ll go bankrupt.” Maybe that's a good argument, and maybe it's not. Either way, it opens the door for all sorts of political giveaways deep within the tax code, which is exactly what we have in the state sales taxes.

"Many states are funded solely by sales taxes (Tennessee) and they tend to have much more consistent revenue streams year-by-year."

It isn't a question of consistency of revenue stream. The question is whether the tax causes people to make different economic decisions than they would have made without the tax. If you tax bread and not meat, then people will eat less bread and more meat. If you tax in-state sales and not out-of-state sales, then people will buy more through over the internet and less in their local brick-and-mortar stores. If you tax goods and not services, then people will buy more services and fewer goods. That’s what fair tax systems try to avoid.

"Plus, many people incorporate and take income in other countries, &c."

Incorporation doesn't necessarily change tax rates, but that gets too technical to discuss here.

It's true that there is some complexity involved in foreign income, but the essentials of taxing foreign transactions favor the income tax over a sales tax: Suppose a US resident does business with someone outside the US. An income tax is on the US resident. The IRS can find and tax that guy. A sales tax would be on the foreigner, who is outside of US jurisdiction. Since you can’t collect that from the seller, you have to collect it from the buyer, which is nearly impossible as a practical matter. That's one of the problems with a sales tax, and it's the same problem that the states are now facing with their sales taxes.

“can I post it on the front page?”

Sure, just take out the last sentence in para 5.1. A sales tax that included all services would become another employment tax, not another income tax. The difference would be unearned income, like from investments.

I don’t claim to be an expert on high-level tax policy. I spend most of my time in the tax trenches. But I know what’s in the US Tax Code, and I know what a sales tax looks like, and I know that a lot of conservative rhetoric on taxes is simply wrong as a factual matter.

I’m not trying to make anybody feel bad with this. I was very tired when I wrote the previous post, and I’m sorry if it was too tart. I mostly just want conservatives to have their facts straight and know what they’re talking about when it comes to taxes, because otherwise they aren’t going to make any progress on improving the tax system.

RJ: I'm all in favor of lower and flatter tax rates. In fact, I’m more fervent about it than most conservatives, because I have actually seen people choose not to do business deals because of taxes. For me, the idea that people don’t work as hard because of high taxes is a matter of personal knowledge. But there are two common misconceptions about rate structure that we should be clear about:

1. A lower and flatter rate structure would not shorten the tax code. Eliminating some of the deductions and credits that currently junk up your Form 1040 would not appreciably shorten the tax code. Most of the tax code and regulations are devoted to topics that most individuals rarely come into contact with. An income tax is a very complicated concept, and it takes a lots of rules to make one that’s fair.

For an idea of what is actually in the Tax Code, look here: http://www4.law.cornell.edu/uscode/26/stAch1.html. In terms of verbiage, the part on income taxes about two-thirds of the whole thing. The rest is mostly estate and gift tax, excise taxes, and tax administration and procedure.

2. A lower and flatter rate structure would not end pork hidden in the tax code. They don't put the pork in the rate structure. It’s scattered in various other places, mostly in the form of tax credits and accelerated depreciation rates.

The graduated rates aren't pork to businesses; they're pork to poor people. The goal of liberals is to make a rate structure so top-heavy that half the voters don't pay any income taxes at all. The regressivity of employment tax balances this somewhat.

A lower and flatter rate structure would reduce tax fraud and tax shelters, simply because people are less interested in evading taxes when the dollar amounts at stake aren’t as high. But those are totally different from pork.

Marty and JP: You both basically admitted that you didn’t read what I wrote, but you’re sure that it’s wrong, whatever it is. I guess your only information about tax policy will come from people who don’t know much about taxation.

Ben, you couldn't be more wrong. I read everything you wrote. You definitely have a handle on the complexity of the current state of the income tax system in this country.

That being said, it doesn't matter how much knowledge someone has about it- it needs a serious overhaul. The American people are robbed of far to much of their own hard-earned money under the current system.

About the only thing the so-called "tax experts" do is navigate us common folk through an overly complex set of rules(that they can't even agree on amongst themselves), and in the process it costs us even more when we pay these experts for their help.

There is one part of your previous post that caught my eye:

"Somebody has to collect the taxes to pay the Marines, and an income tax is the fairest kind of tax we know how to collect."

Obviously you still think the income tax actually funds government operations. That's crazy. We have a system based on fiat money here, Ben.

The IRS could be abolished tomorrow, and a right-sized government could operate just fine off of other existing taxes (although some adjustments would have to be made).

More importantly than all of the above, it is ridiculous to think that government is ever going to solve anything. With that, I'll admit that half of me thinks the IRS should just stay put- I'm afraid of what will replace it. It might just be worse.

BB: The most interesting point you made is that taxing all goods and services alike would basically be the same as an income tax. Except, of course, that money not spent wouldn't be taxed immediately. I'd be happy with a flat income tax, if the withholding system were eliminated.

JP: Worry about "fiat money" is misplaced. It's a complicated topic, but government is certainly not funded merely with the will power of politicians.

Jim, you're mixing ideas together here. Let's try to separate them:

Complexity
"About the only thing the so-called "tax experts" do is navigate us common folk through an overly complex set of rules"

People generally feel that just about any area of the law is unnecessarily complex. The unspoken idea here is that the law should be accessible to non-specialists. But that's utopian thinking. The law has never been simple enough for non-specialists to understand, and it never will be. The law is complicated because human interactions are complicated. And the more complicated our interactions become, the more complicated the law will become.

This is true in tax law, just as it is in other areas of law. The more varied and complex our economic situations become, the more rules we need to define how they're taxed.

Here's a tax law to think about: IRS agents will prowl the streets, clubs in hand, seizing random amounts of whatever money or valuable property they find. There's only one tax law: Do what the man with the club says. It's difficult to plan your finances, of course. And some people will be taxed heavily while others pay nothing at all. But it's wonderfully simple!

We used to have a very simple trial system, too. Our forebears didn't bother with the motions, rules of procedure, and laws of evidence that bog down modern proceedings. They had things like trial by combat, or trial by ordeal. No doubt sometimes the innocent were punished and the guilty went free. But it was simple!

Come to think of it, there is one area of modern law that has this level of simplicity: personal injury law. Gone are all those fusty rules of fault and contributory negligence. Modern law in this area is: 1) If someone is injured, 2) preferably someone appealing, like a child, 3) and they have a horrible injury of some sort, especially one that makes people recoil in horror and pity, and 4) they hire a lawyer who is a good enough actor to make people cry, and 5) someone who was in some way associated with the injury has a lot of money on hand, and 6) that person is unappealing to a typical juror, like a big corporation or a rich doctor, then 7) the injured person can win millions and millions of dollars.

There's a simple little seven-part law. How do you like it? I think it stinks. I think we need really complicated ideas like contributory negligence, assumption of the risk, tighter rules on junk science expert testimony, more judgments non obstante veredicto, and . . .

Oh, there I go again, talking about legal complexity, making things more complicated when they're simple. You don't want to hear it, right?

Law is inherently complicated. Men don't make it so. Most law is not the arbitrary pronoucements of sovereigns. It is the exploration of endlessly multifaceted ideas like guilt, evidence, property, and income. When you get down to it, complaining that law is complicated is like complaining that there are too many elements on the Periodic Table.

Taxes Too High
"The American people are robbed of far to much of their own hard-earned money under the current system."

I completely agree. Before I took my first tax law course in law school, I too thought that the amount of money taken by a tax was in some way connected to the tax itself. I was sure that the class on tax law would become a sort of political battle. I was dreading it.

I was completely wrong. Tax law is applied economics. It has very little to do with politics. The income tax rate can be 1% or 80%, but the tax code will stay pretty much the same. The tax rate has nothing to do with most of the tax code.

If you want lower tax rates, then your complaint is with the legislature. Don't blame the IRS. They didn't set the rates.

???
"Obviously you still think the income tax actually funds government operations. That's crazy. We have a system based on fiat money here, Ben."

I have no idea what your point is here, Jim. Yes, we have fiat money. Yes, the income tax funds a large part of government operations. What's the connection?

Down with the IRS!
"The IRS could be abolished tomorrow, and a right-sized government could operate just fine off of other existing taxes (although some adjustments would have to be made)."

Call it whatever you like; somebody has to collect the taxes to provide whatever level of government operation you think is appropriate. As my tax law professor always said, "Somebody has to pay the Marines." Maybe that can be done entirely without an income tax, through some collection of tariffs and user fees. But the question should be: Is that method of raising money better than the alternatives?

Truth be told, I would much rather work with the IRS than with state tax collectors. I know it sounds strange, but I work with both of them all the time. The IRS has clearer rules, a better web site, and a more generous attitude than any state I've had contact with.

Out of the Frying Pan
"With that, I'll admit that half of me thinks the IRS should just stay put- I'm afraid of what will replace it. It might just be worse."

It would very likely get worse. That's my point.

We will always have tax collectors. They have been around for as long as there have been governments. The income tax is the fairest tax yet invented---certainly fairer than a sales tax, an estate tax, or a property tax. Get rid of it and you're taking a step backwards.

MW: "The most interesting point you made is that taxing all goods and services alike would basically be the same as an income tax."

If we played Socratic dialogue long enough, we could start with a sales tax and end up with an income tax on earned income. (The extent to which unearned income like dividends and capital gains should be taxed is an open question, which is why it's the subject of so much congressional debate.) If you go methodically through the economic distortions that sales taxes create, you'll find yourself working steadily towards the idea of income.

Mixing ideas is impossible not to do. Notheless, I enjoyed your comments. Allow me to respond.

1) "There's only one tax law: Do what the man with the club says."

Ironically, this is not far from the present-day truth. We either pay what they tell us to pay, or we will lose a war against unlimited resources.

2) "Law is inherently complicated. Men don't make it so."

I agree with the first sentance, but wholeheartedly disagree with the second. The law is complicated. But to say that men don't make it so is either foolishness or arrogance. Men, by their very nature, indeed make it so. And we have since the fall of Adam. We try to build a better mousetrap with an imperfect mind, and we expose yet another flaw, that needs yet a better idea, and so on, ad infinitum.

3) "If you want lower tax rates, then your complaint is with the legislature. Don't blame the IRS. They didn't set the rates."

I place blame where blame is due. The IRS is complicit by virtue of being the "men with clubs" that collect the money. Throw the Judicial system in there while we're at it. They take long strides in keeping angry citizens and watchdog groups from totally exposing the corruption inherent in all parts of government that directly, or indirectly, run the income tax system in this country.

4) "I have no idea what your point is here, Jim. Yes, we have fiat money. Yes, the income tax funds a large part of government operations. What's the connection?"

Perhaps you misunderstood me (or I mistyped). What I meant to say, was that the government would not fall apart if the income tax were abolished (and I don't mean because they'd institute something else right away). They might have to tighten their belts a little, but they certainly wouldn't die on the vine. We've got $87 billion laying around to throw at Iraq? I think we'd survive. (My views may be simplistic; complexity is such a bore.)

5) "The IRS has clearer rules, a better web site, and a more generous attitude than any state I've had contact with."

That may be true in your case, but I personnally have observed recieving different responses to the same tax question. The rules are so complicated, they (collectively) don't know what they agree on. And if you consider a canned form letter to be a generous attitude, then you, my friend, have a very generous attitude.

6) "It would very likely get worse. That's my point."

In the end, it seems as if we agree. But I find it ironic to come to the conclusion that it's better off NOT to fix something that is so deserving of being fixed (read: destroyed).

Interesting posts...but you all really miss the point. If you want to correct the situation...look the devil in the eye and slay it...the Fed.

The tax laws that have changed to make the IRS less stringent toward the people is a joke! Not only do they not work with you to settle for a lower amount, but they double dip at the same time. By that I mean that the IRS sends you a form to fill out if you owe for the last year and give you 14 days to get the completed form back to them. Then they may not get back to you for 6 to 10 months. But every 3 months they charge you with interest and penelties. When I asked about this, they told me that they were working on other cases and would get to mine when they could. So there you have it. They are charging you the citizen and are not even working on your case at all!! No one at the IRS can tell me why the IRS takes 10% of you 401k if you widthdraw it early either. What did they do to earn that? It's been on the news that the people that are putting the max in their 401k's are going to have a big surprize when they start to draw it out. The IRS ends up with over 60% of it depending on how much you take out. I, as well as most of the citizens say. Get rid of the american gestopo...Get rid of the IRS!!!