Taxes Got You Confused? You're Not Alone

Why Is The American Tax System So Difficult To Navigate?

The US tax system is even messier than your favourite reality TV show storyline. Check out our primer on personal taxes to learn the basics.

And what's the outcome of all that mess? To most people,  it feels to impossible to understand and correctly file your taxes. According to a 2013 estimate from the IRS, the average American spends 13 hours preparing and filing their taxes.

Tax policy experts are asked why the US tax system is so darn convoluted, and the explanation is itself, convoluted.  They say it has a lot to do with the tax rule exemptions that legislators have created for specific groups and causes, as well as the political nightmare that changing the system would create, making it a vexing nonstarter.

Why not just get rid of all those deductions and credits for things like charity giving and having children, and stick to the basics? Daniel Bunn, an expert on tax policy at the Tax Foundation, compared eliminating these carve-outs to removing several coats of globby white paint from a dilapidated old home.

“You might have the authority to be really aggressive and get all those coats of paint off,” Bunn said—but even if the majority of Americans are fine with you working your way through the layers, special interest organizations will undoubtedly slow you down.

Enigmatic Policies

Tax lawyers and congressional staff write elaborate tax laws to avoid their exploitation, which means “you're left with a system that's incomprehensible," according to Howard Gleckman, who studies tax legislation.

In a nutshell, the IRS's goal is to change particular behaviors. One example is the home interest mortgage deduction, which allows homeowners to deduct interest on up to $1 million—or $750,000 if they buy their property after December 15, 2017—in home debt. In a more basic tax system, such a benefit would not exist, but neither would the incentive to acquire real estate.

The tax-reform push isn't limited to individuals, either. In the two decades leading up to the Tax Cuts and Jobs Act (TCJA) of 2017, corporations paid a 35% tax on most profits, which might have discouraged small firms from converting their sole proprietorships and partnerships, whose income is taxed at individual rates, into corporations.

The TCJA reversed that tax incentive, raising the corporate rate to a low 21%. And with President Biden wanting to raise the rate to 28%, small firms are unsure what's best.

Some nations do it better

According to experts, taxes shouldn't be this complicated. We'd have to go to eastern Europe if we wanted to see the most effective tax system in action. Estonia, in particular, gets praise for its online, non-complicated tax code, according to Bunn.

One, the country's tax regulations are simple. They're so basic that some taxpayers spend less than a minute preparing their taxes. And it's only possible because to the Estonian government's amazing technology.  Bunn said: “In Estonia, you've got basically all of government services digitized. So it's really easy to go in and apply and look at your pre-filed tax forms and things like that.”

The IRS doesn't deserve much credit on the tech side of things. “It's not like the IRS is writing everything with pen and pencil,” Bunn said. “There is tech, but we're still faxing information and things like that.”

Why can't the USA do it better?

So if Estonia can make it that easy, why can’t the USA? There are several reasons.

The first step to achieving peace of mind is for countries with simple tax systems to levy a value-added tax (VAT), according to Gleckman. VATs are levied at every stage of the supply chain, where value is added, and are an example of a value-added tax.  The US currently does not have VATs, which are the third-largest source of tax revenue for members of the Organisation for Economic Co-operation and Development.  Individual sales taxes, which are collected and retained by individual states in the United States, account for just 12% of total tax revenue to states and local governments. Most states' tax revenue is made up of  federal funds, property taxes, individual state income taxes, and fees for things like public university tuition.

VATs are bipartisan-ly unpopular in the US.  “It's been a joke for a long time that Republicans don't like value-added taxes because they think they're too easy to raise, and Democrats don't like value-added taxes because they think they're regressive,” Gleckman said.  The regressive tax system disproportionately targets lower-income taxpayers, who pay a higher percentage of their income in taxes than high-income individuals.

VATs may be regressive if they are not modified, according to Gelman. With a minimal adjustment, VATs can be made progressive: giving a credit against a specified amount of yearly VAT payments. Despite the fact that tax policy experts have shown that VATs may be done correctly, an unending lack of political appetite on both sides “makes it kind of impossible to pass.”

However, Gleckman foresees a VAT in the country's future—but not for some time. The answer to "How do states tax digital advertising?" may be "Through a VAT."

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