Report highlights the need to overhaul U.S. tax system

P RESIDENT Trump and Congress are working on tax reform proposals. The politics of a major tax overhaul may be complicated, but the need for change is undeniable, as a recent report from Sen. Jeff Flake, R-Ariz., makes clear.

Flake’s “Tax Rackets” report highlights several tax breaks the senator considers to be of dubious merit. But the report also shows how such tax breaks distort the whole system.

Flake reports that the average taxpayer owed $9,655 in federal income tax last year, an effective tax rate of 13.5 percent. And that doesn’t include payroll taxes. Combine income and payroll taxes, and the total tax rate “exceeds 30 percent of total annual earnings.”

Yet at the same time, 76.6 million Americans, or 44 percent of all tax filers, pay no income tax. “This includes about 4,000 earning at least a million dollars,” Flake writes.

There are even 31 million who will pay neither income nor payroll taxes.

The United States’ top corporate tax rate of 40 percent is “the highest corporate tax rate in the world,” Flake writes. “Yet, many corporations have not paid any federal income taxes for years.”

Those individuals and corporations have done nothing illegal. They’ve merely taken advantage of existing tax breaks. The problem is that some groups are favored more than others. Thus, some businesses pay a much higher effective tax rate than others of similar size.

What’s more, federal officials can’t even agree on how many federal tax breaks exist. Flake points out the Congressional Budget Office reports “over 200 tax expenditures while the Department of Treasury counts 169.”

Even tax breaks that initially appear to make sense have generated waste and abuse.

State and local municipal bonds are not subject to taxation, which makes them attractive to private investors seeking to legally reduce tax payments. (Flake cites research suggesting bond investments alone explain how thousands of people with incomes exceeding $200,000 avoid paying income tax.) The tax break also provides an indirect subsidy to state and local governments by guaranteeing low-interest borrowing rates.

Yet that system doesn’t always generate wise use of public dollars. Flake writes “… Planned Parenthood’s national headquarters in New York and a New Jersey mega-mall that is bigger than the Empire State Building and contains an indoor ski slope, are also being financed with tax-exempt municipal bonds.”

Alpacas were rare in the United States 30 years ago, and the market for the animals’ fleece “never took off,” Flake writes. But a tax write-off for the animals has created demand for them.

“Since most of the federal tax benefits are taken in the year of purchase, however, the alpacas are often abandoned when they can no longer be used as tax shelters,” Flake reports.

The list goes on, but Flake argues that the examples highlighted in his report “demonstrate how legal loopholes and clever accounting provide tax havens and subsidies for the well-off, create artificial markets, encourage more government spending and debt, and shift the tax burden to middle class workers.”

A valid overhaul of the federal tax code could fuel greater private-sector job creation and broader economic growth. This report by Flake shows reform could also ensure greater fairness in the system and less economic waste.