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How the tax system has gone off the rails

May 04, 2011

The best summary of the ills of the federal income tax I've seen was presented yesterday to Congress by Scott Hodge of the Tax Foundation. It has so much good stuff that it's hard to excerpt. Some highlights:

Over the past two decades, lawmakers have increasingly asked the tax code to direct all manner of social and economic objectives, such as encouraging people to buy hybrid vehicles, turn corn into gasoline, save more for retirement, purchase health insurance, buy a home, replace the home's windows, adopt children, put them in daycare, take care of Grandma, buy bonds, spend more on research, purchase school supplies, go to college, invest in historic buildings, and the list goes on.

The U.S. tax system is in desperate need of simplification and reform. The relentless growth of credits and deductions over the past 20 years has made the IRS a super-agency, engaged in policies as unrelated as delivering welfare benefits to subsidizing the manufacture of energy efficient refrigerators. I would argue that were we starting from scratch, these would not be the functions we would want a tax collection agency to perform.

The development of the IRS into a cross-functional superagency is a terribly underreported story (except here, of course).

Second, as a consequence of trying to use the tax code to help the "middle-class," we have knocked millions of people off the tax rolls, turned the IRS into an extension of the welfare state, and created a growing class of people who are disconnected from the basic cost of government.

It's not good when 51% can vote to tax the other 49%.

Lastly, while some people would like to make the tax code more progressive, the fact is that the U.S. already has the most progressive income tax system of any industrialized country. The top 1 percent of taxpayers pays a greater share of the tax burden than the bottom 90 percent combined. Moreover, the nation's tax and spending policies currently combine to redistribute more than $826 billion annually from the top 40 percent of families to the bottom 60 percent. We should have an honest discussion over how much redistribution is considered fair.

If you don't want to read the whole thing, it's worth visiting just for the pictures. First, how people are becoming disconnected from the cost of government:


Sure, spend more, the rich guy is buying anyway:


Ah, you say, those charts don't take into account payroll taxes, which are regressive! They don't take into account government benefits either. This one does:


This means the bottom 10% of taxpayers receive more than ten times as much in benefits as they pay; the entire bottom 50% of taxpayers receives more in benefits than it pays. And if you are tempted to say "but what about payroll taxes?", this chart counts all federal taxes, not just the income tax.

Hat tip: Paul Singleton

Update: TaxProf, 51% of Households Pay No Income Tax; Share of Taxes Paid by Rich Growing Faster Than Income

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and yet the irony is that most politicians and pundits think we have a revenue problem, that simply raising marginal rates will ease all of our budget problems. The emergence of refundable credits (using the tax code as a Keynesian mechanism) is what is affecting tax revenues. We have to squeeze more juice out of fewer lemons. If you look at the numbers, the amount of refunds issued
by the government has dramatically increased from $196 billion in 2000 to $467 billion in 2010. We actually have collected about $300 billion more tax revenue in 2010 than we did in 2000, from only a slightly larger tax base (there were about 4 million more taxpayers in 2010 than in 2000.

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