For over four decades there have been unrelenting calls to make the tax code “fair, simple, and efficient.” But despite nine major tax acts between 1969 and 2003, along with many less extensive tax acts, the refrain for a “fair, simple, and efficient” tax code has continued to be heard. This continuing plea is not surprising, because over the decades the tax system has evolved to ask the highest income earners to pay less in taxes, become ever more complex, and eschewed “efficiency” in favor of the allowance of an ever-increasing number of tax preferences. Tax act after tax act failed to produce a fair, simple, and efficient tax code. The recently enacted Tax Cuts and Jobs Act is simply another failure to enact tax reform that provides a fair, simple, and efficient tax code. The call for a “fair, simple, and efficient” tax code has become a mere trope. True “tax reform” entails revising the tax code better to meet normative tax policy criteria.
“Fairness” needs to be determined with respect to the extent to which the tax code provides both horizontal and vertical equity. The tax burden on similarly situated taxpayers should be equal. If a dollar is a dollar, then two taxpayers (or households) with equal incomes, however derived, should pay equal income taxes. Vertical equity means that taxpayers with greater income than others should pay appropriately greater taxes. This criterion has been interpreted to call for imposing graduated progressive rates, including very high marginal rates on extraordinarily high incomes, based on the ability to pay principle, reflecting the diminishing marginal utility of money. These equitable criteria call for repeal of preferential rates for capital gains.
Determining ability to pay requires re-examination of the role of itemized deductions and the standard deduction. The standard deduction should be abolished. Deductions for unreimbursed employee business expenses, producing investment income, casualty losses, medical expenses, and state and local taxes should be allowed without any significant limitation. In reality, the tax system cannot be “simple.” All that we can ask is that the tax system is not unnecessarily unduly complex. That means minimizing special rules that are not necessary accurately to determine economic income or ability to pay consistent with both horizontal and vertical equity principles.
“Efficiency” requires structuring the tax system to minimize interference with economic decision-making. To the greatest extent possible, the tax law should be neutral, taxing every investment made by a particular taxpayer identically and taxing all industries identically. In this regard, the Internal Revenue Code is an abject failure. It is replete with special provisions — tax expenditures — favoring various investments by various industries to one extent or another. It is long past time to pay more attention to the wisdom advanced over fifty years ago by Stanley Surrey in his analysis of the systemic problems created by introducing spending provisions through tax expenditure preferences in the tax code.
An efficient tax system requires that all businesses, however organized, should be taxed at the entity level under a system that applies the same bases rules and rates to all businesses. The only distinction should be with respect to the treatment of distributions from publicly traded business entities and distributions from privately held businesses. Distributions from publicly traded business entities should continue to be taxed as dividends. Distributions from privately held businesses should be taxed to the owners by applying the imputation-credit model for corporate tax integration.
Martin J. McMahon Jr., 2018 Erwin N. Griswold Lecture Before the American College of Tax Counsel: Tax Policy Elegy, 71 Tax Law. 421(2018)