Ending April's Cruelest Day

"If you are married filing separately and your spouse files Form 1040 and itemizes deductions, see page 36 and check here. Enter the standard deduction shown below for your filing staus. But if you checked any box on line 18a or b, go to page 36 to find your standard deuction. If you checked any box 18c, enter -0-....If line 27 is more than 28d, subtract line 28d from line 27 and see page 43."

Look familiar? This is your simplified 1993 personal income tax return, one of many different tax forms the IRS estimates Americans spend over 613 million hours each year to complete.

The 1040, complex itself, is just one aspect of the multitude of different forms, rates, deductions, exemptions, credits and bureaucracies which make up the U.S. tax system. Our present system is excessively complicated and inefficient, as thousands of tax lawyers devote their lives to finding loopholes and other ways to evade taxes wasting billions of dollars.

The income tax code, thousands of pages long, is in dire need of simplification. We could dramatically improve our tax system by implementing a value added tax (VAT) to replace the personal income, corporate income, and payroll taxes.

A VAT of about 20 percent would produce the same amount of revenue, with many benefits, not the least of which is its simplicity.

Calculating taxes under the current system is not as simple as it sounds because taxpayers have to account for deductions, inflation and depreciation, just to name a few such complications. In fact the problems which arise from income and payroll taxes are inherent in the tax base. These inefficiencies can be reduce but not eliminated so long as the government retain income as the tax base.

For consumers, the VAT tax would be easily computable, since it is much like a retail sales tax; with a 20 percent VAT, a good or service which costs $100 would be taxed $20. There would be no deductions, exemptions, or credits to worry about. Thousands of pages of tax codes and regulations could be done away with.

The VAT would not present extra difficulties for companies, since under a VAT (such as the type currently use in Japan), businesses would not be burdened with complex tax calculations. They would not have to make any significant changes to incorporate the VAT, since their own accounting records supply all the necessary information to calculate the tax. Instead, they would reap tremendous gains from throwing away the current complicated tax-calculation apparatus.

The compliance costs for the corporate and payroll taxes are currently extremely high. Switching to a VAT would allow companies to spend more on wages and investment, and less on tax lawyers.

Critics of the VAT point to the complexities of VATs in Europe. While it is indeed true that European countries have experienced high administrative and compliance costs, this complexity has been the result not of the VAT itself, but of the numerous exemptions (housing, charity, food) which European governments have decided to institute.

The most efficient VAT is one without any exemptions, which is the type of VAT the U.S. should adopt. The problems European countries face with their VATs are the result of their decisions to make their system more complex.

Although simplicity is important, the VAT's most significant benefits are its neutrality and fairness. Simply put, a VAT does not distort economic behavior. Economists generally agree that the best type of tax is one that does not change incentives, since incentives create deadweight losses and reduce consumer welfare more than necessary. Distortions result in inefficient allocations of resources, which slows growth and hurts everyone.

For example, corporate income and capital income taxes reduce savings. Personal income taxes lower both savings and the labor supply.

Savings and capital formation are the keys to economic growth, and compared to other industrialized nations, the US savings and investment rates are abnormally low. Our current tax system's anti-savings bias is a major cause of this. Our low savings rate inhibits economic growth and future productivity.

Replacing current taxes with a VAT would remove the bias towards consumption, and thus cause savings to increase. This, in turn, would result in the creation of more jobs and an increase in economic growth.

A VAT would also be fair and equal. It would be a proportional tax which would have similar effects on all income classes. Fairness would be achieved since those with similar incomes would pay similar amounts of taxes. This would be a vast improvement over the present system in which people with the exact same incomes often end up paying dramatically different amounts of taxes as a result of loopholes and differences in the composition of consumption.

Although most economists agreed that a VAT can successfully achieve horizontal equity, a traditional criticism focuses on vertical equity since the VAT is allegedly regressive. There are two problems with this criticism.

First, opponents' claim of regressiveness is questionable, since studies have shown that the VAT is not as regressive as payroll taxes which are currently in the US to generate as much as a fifth of total revenue. Furthermore, if the VAT is regressive, the government can easily offset this by granting refundable tax credits (such as the Earned Income Tax Credit).

For example, families below the poverty line could receive a credit of about $3000, which would be about the amount they paid in taxes. As income rose above the poverty line, the size of the tax credit could be reduced as appropriate.

Under this system, the long 1040 form would be reduced to a postcard, a postcard people would enjoy filling out since they would not be paying taxes, but receiving a check from the government in return.

In short, by implementing a VAT and granting income-adjusted refundable tax credits, the government can have the best of both worlds: efficiency and equity.

A VAT would also help the United States reduce its trade deficit. Because U.S. firms would no longer pay corporate taxes, they would be more competitive in international markets.

At the same time, a VAT would be easier to enforce. The compliance rate in the United states is less than 90 percent for income taxes and around 65 percent for capital gains tax, whereas the compliance rate for VATs in Europe and elsewhere is in the high 90s. This is largely a function of the simplistic format of the VAT.

The way to reform tax policy is not to simply build level upon revel of complex hierarchy into the code. Instead, the format must be simplified. Americans have a right to an efficient tax system that does not waste their time and hard-earned dollars.