Overhauling the Tax Code


Despite his failure to pay $34,000 in self-employment taxes, Timothy Geithner was confirmed as Obama’s treasury secretary last week. We’ve now learned that Tom Daschle, Obama’s health secretary nominee, failed to pay taxes associated with his use of a car and driver provided by a wealthy friend between 2005 and 2007. The specifics of their tax problems have been widely reported, so I won’t revisit them here. Suffice to say that a close look and their situations raise serious ethical concerns both about Obama’s commitment to “real change” and those who will be appointed to implement it. But there is an opportunity for conservatives here. If Geithner and Daschle’s mistakes were simply “honest oversights” as we have been told, then why not pressure Obama to endorse a complete overhaul of the system so convoluted that even seasoned members of Obama’s cabinet can’t figure it out?


The current confusion is a result of years of Congressional meddling. Every year, Congress tacks on (sometimes) well-intentioned provisions and loopholes to the federal tax code to reward or punish particular behavior.  However, there are 3 major problems with manipulating the tax code this way. First, this massive social engineering effort restricts our individual liberty to manage our economic affairs as we see fit. “Tax credits” lower the taxes of those who meet certain requirements at the expense of the rest of the taxpayers.


Second, the unintended consequences of the tax code prompts individuals and corporations to make decisions that would otherwise not be in their best interest. Consider health insurance. The fact that employer-sponsored premiums are not counted as part of taxable income means that 25-33% of the cost for middle income families is subsidized by the federal government. Individual health care expenses are only partially deductable (depending on other factors), giving Americans a financial incentive to purchase heftier insurance policies at Uncle Sam’s expense. Even well-intentioned proponents of social engineering schemes seem to ignore such unintended consequences when the propose additional layers to the tax code.


The third problem is compliance costs. IRS estimates suggest that Americans spend about 7 billion hours filling out tax forms and over $200 billion in tax compliance costs. Put another way, taxpayers spend about $1 in compliance for every $5 the IRS collects. Academic studies estimate that overall tax compliance costs in the U.S. are about 2-2.5% of GDP. This might not sound like much in the era of trillion dollar bailouts and stimulus packages, but it represents a large sum of money extracted from the economy for no real benefit.


Ethical concerns aside, Geithner and Daschle are reflections of a cumbersome tax code in need of overhaul. A flax tax with only a few basic deductions would be a massive improvement, and a national sales tax (instead of an income tax) would be the ideal. Socialists rarely support common sense attempts to simplify the tax system, however, because the current approach enables them to manipulate the citizenry, buy votes with “tax credits,” and redistribute wealth. This is why overhauling the system—not just cutting taxes—must be a key part of the Republican agenda if it is to offer any real alternative to Obama’s agenda of central planning and redistribution.



5 thoughts on “Overhauling the Tax Code

  1. Dr. Parnell, Good article. Can you please explain how the subsidy works that you mention in paragraph 2? I couldn’t follow that too well.

  2. OK…Let’s assume that you’re in a 25% income tax bracket and that $6000 per year is spent in pre-tax dollars through your employer for health insurance. This would reduce your tax bill by 25% of $6000, or $1500. In other words, the government is paying $1500 of your health insurance bill and you are paying the other $4500. This tax break is designed to give employers an incentive to offer health insurance to their employees. The problem is that you might not think the policy is worth $6000 per year, but you might keep it because you are only paying $4500. In this situation, you are getting more insurance than you really want because the government is paying for part of it.

    This can get even more complicated. Because we are “the government,” tax rates must be raised to compensate for the health insurance deduction to keep government revenues constant. Therefore, if the government pays part of everyone’s health insurance, then each us will have to pay higher taxes to make up the difference. This means that we might end up paying the same amount in taxes anyway because we are subsidizing each other’s health insurance, often for plans that are not what we would buy on our own. The point here is that we need to think through these well-intentioned tax credits. Sometimes they do more harm than good.

    1. The Heritage Foundation (www.heritage.org), The Tax Foundation (www.taxfoundation.org) and the Cato Institute (www.cato.org) publish a lot of good work on the problems with the current system and ways to fix it.

      Here are a couple of specific suggestions. There are 2 competing options for simplifying the tax code, both of which would be major improvements over the current system. The first is a simplified FLAT TAX. The Heritage Foundation has a nice primer on how this would work:

      The second option is a NATIONAL SALES TAX, also dubbed the FAIR TAX. The Fair Tax Book: Saying Goodbye to the Income Tax and the IRS (2006, by Boortz & Linder) outlines a specific proposal in some detail. They also have a website (www.fairtax.org), but the deeper economic arguments are found in the book. They came out with a sequel in 2008, I suggest that you start with the 2006 publication. It’s a fairly quick book to read.

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