The pandemic leaves all levels of government desperately needing revenue. Normal tax revenues have declined and expenses have gone up. To help solve this problem, tax proposals abound, particularly for new taxes for ultra-wealthy individuals who are often viewed as not paying their fair share. Despite producing some revenue, new taxes also bring new legal and administrative challenges. Worse yet, a focus on new taxes to solve governmental budget problems masks this reality: we have defects in our existing taxes that result in significant revenue leaks and bad tax policy.
As a tax scholar, CPA and attorney, deeply immersed in tax law and policy matters for more than 30 years, I strongly urge lawmakers to direct any revenue generating efforts towards fixing the fundamental flaws in our existing taxes rather than attempting to semi-solve budget problems with new taxes. While targeting the ultra-rich with new taxes sounds like a simple revenue fix, it allows long-standing, poorly designed tax exemptions to continue to drain the bank.
U.S. Sens. Bernie Sanders (I-Vt.) and Elizabeth Warren (D-Mass.) each promote a new federal tax on individuals with net worth in excess of at least $50 million. California lawmakers recently proposed AB 2088, a tax on the worldwide net worth of Californians with wealth above $30 million. New York lawmakers are considering S8277B, a tax on individuals with net worth transcending $1 billion. Generally, wealth encompasses cash, cars, yachts, real estate, stock, art, bitcoin, pension funds and more.
Despite variations in how these new taxes on ultra-rich individuals would work, one commonality is that they divert our attention from the leaks in our existing tax foundations. We wouldn’t build a second story on top of a weak first floor. That new structure would create more problems and misdirect time and effort from fixing the foundation. Same with a tax system. We should fix our existing taxes before adding new ones. The fixes can capture revenue leakage from our faulty system including from taxpayers who most benefit from the flaws, typically those with high income. The fixes can make new taxes unnecessary.
All taxes have structural flaws mainly because we try to do more with our tax system than just raise revenue for government operations. Our current tax laws overflow with unnecessary and structurally inappropriate deductions, exemptions and credits. This makes taxes more complex and inequitable than they should be while also diminishing tax revenues and supporting high tax rates.
The personal income tax should include one’s income from all sources reduced by expenses to produce that income and a deduction representing a portion of one’s income that should not be taxed because we need it to live on (personal and dependency exemptions and the standard deduction serve that purpose). This means, for example, there should be no deduction for mortgage interest on primary and vacation homes. Fringe benefits, which can easily be worth over $10,000, should be taxed to employees rather than excluded from the income tax. And appreciation that exists in assets when someone dies should not get a free pass from income taxation. That is a significant tax break for the wealthy yet ignored with the wealth tax proposals.
Improperly structured taxes result in large tax reductions for higher income individuals. The mortgage interest deduction and fringe benefit exclusion reduce taxes more for higher income individuals because they are in a higher tax bracket. In addition, these folks are likely to have a larger mortgage and greater fringe benefits than others, which further increases their savings from these tax breaks.
The flaws extend beyond the income tax. The sales tax also has shortcomings in need of attention. Although the sales tax is a consumption tax, many states exempt food, diapers, home utilities and personal services. That makes little sense. And because higher income folks spend more on these exempt items, they get the biggest tax savings from this structural flaw.
Eliminating special rules can generate needed revenue and even allow for a rate reduction. Changes can be designed to capture revenue leaks that benefit high income individuals while limiting or avoiding tax increases for those with lower incomes. For example, taxing gains in appreciated assets at death could exclude individuals with less than $500,000 of assets. Adding currently exempt personal consumption to the sales tax base can include a refundable income tax credit for lower income individuals. Sales tax on household utilities can easily be added to monthly bills but only if the bill exceeds what it costs to provide utilities to a 1,200 square foot home. These are the types of improvements that can be made to existing taxes to generate revenue without harming lower income individuals.
No doubt, changing long-standing state and federal rules won’t be easy, but that’s not a good reason to ignore the leaks and inequities we currently have. Eliminating costly and unnecessary tax breaks in our current taxes is the kind of proposal we need. Let’s fix the taxes we have before deciding that a new tax is needed.
Annette Nellen, CPA, Esq. is an accounting and taxation professor at San Jose State University and a Public Voices Fellow with The OpEd Project.