When the personal income tax was signed into law in 1913, a mere half percent of the population filed an individual tax return. Today, nearly half the population files an individual tax return, and the personal income tax represents the largest source of revenue for the federal government.
According to the Joint Committee on Taxation, the individual income tax will account for 48.5% of federal receipts in 2017. (See ‘Overview of the Federal Tax System As In Effect for 2017,’ Published March 15, 2017 at www.jct.gov).
The Trump Administration’s proposal for Individual Tax Reform is focused on the following three things:
- Reducing the seven tax brackets to three tax brackets (12%, 25%, and 35%);
- Doubling the standard deduction; and
- Providing tax relief for families with child and dependent care expenses
What’s interesting is that when the personal income tax was introduced over 100 years ago, it actually included 7 separate tax brackets. The government also allowed for various tax expenditures, including the home mortgage interest deduction, the deduction for taxes paid to state and local governments, and the exclusion of interest on government bonds.
Thus, the structure of the individual income tax has largely remained the same over its 100-year existence. The main difference, however, is that in 1913 there were only 2 pages of instructions that accompanied Form 1040. Today, we have over 200 pages of instructions and nearly 200 supplemental forms tied to the individual income tax.
Reducing the current tax brackets from 7 to 3 would make our system simpler than it is today, but it could also make it less progressive. This means, if all else remains the same, less revenue would be collected by the federal government over the 10-year budget window.
Doubling the standard deduction would also add simplicity to the individual income tax calculation. A standard deduction that is twice the size it is today means fewer taxpayers would need to itemize their deductions, which would allow them to complete a simpler tax form.
It also means more taxpayers would be exempt from the individual income tax altogether. For example, if the standard deduction is increased to $24,000 for a married couple, it means that a couple could earn up to $24,000 before being subject to the federal income tax.
And that’s certainly not the ceiling. Consider the additional tax benefits that may be available to the couple — expanded child tax credits, EITC, and a new credit for non-child dependents – allowing them to earn substantially more than $24,000 before being subject to federal income taxes.
As the Administration moves forward with its tax plan, it will be important to weigh the long-term impact of implementing new tax expenditures at the same time it reduces tax rates. Generally, a reduction in tax rates requires a broadening of the tax base — so the government can continue to collect the same amount of revenue.
With nearly 200 IRS forms tied to the individual tax return, there’s no doubt our system is in need of reform. The challenge, however, will be balancing the benefits of increased simplicity with the decrease in revenue that generally results from rate cuts and other provisions that make the system less progressive.
Such a challenge will require compromise from both chambers of Congress and the White House as the process moves forward. Without compromise, a revenue-neutral tax reform package will be hard to achieve
ABOUT THE AUTHOR
Tara Fisher is an independent tax consultant. Her professional background includes working for the United States Congress Joint Committee on Taxation, the University of Pittsburgh, and the national tax practice of Pricewaterhouse Coopers. Tara is a Certified Public Accountant and holds a Master of Science in Accounting from the University of Virginia.