A new report from the U.S. Office of the Taxpayer Advocate notes that federal tax law is now nearly 4 million words in length and the resulting complexity forces most Americans to hire professionals to do their taxes. U.S. Rep. Dave Camp, R-Mich., sums up the code as being “10 times the size of the Bible with none of the good news.”
Things may only get worse due to President Barack Obama's focus on raising taxes on “the rich.” History shows the more politicians raise rates, the more they carve out complex exemptions to benefit favored industries or causes.
Want proof? Look at the exemptions the Obama administration insisted on including in the recent tax-raising “fiscal cliff” deal. Even as Obama sought a major tax increase, Reuters reported his administration insisted on around $64 billion in tax breaks for “companies involved in wind energy, auto racing, rum, Hollywood films and much more.” Apparently Obama's call for shared sacrifice doesn't apply to Hollywood millionaires, just those who can't afford a lobbyist.
Liberals often pine for the 1950s, when the top income tax rate was as high as 91 percent. But as James Pethokoukis of the American Enterprise Institute notes, the 1950s tax code was “full of loopholes.” In a 2012 paper, Joseph J. Thorndike, director of the Tax History Project at Tax Analysts, noted that the high income tax rates of the 1950s were often offset by favorable capital gains treatment, breaks on dividend income and a very generous depreciation regime.
By 1961, Thorndike points out, deductions in the highest income group totaled 20.4 percent of adjusted gross income, up dramatically from 12.9 percent in 1954. By 1961, thanks in part to lower rates for capital gains, those earnings represented 75 percent of reported income for the wealthiest cohort of Americans, up from 40 percent in 1953.
Those figures show how demand for tax shelters rises with income tax rates. That's one reason higher rates often fail to generate greater revenue. When the top income tax rate was 91 percent from 1951 to 1963, Pethokoukis notes, the revenue generated was equal to 7.7 percent of gross domestic product. In comparison, between 1988 and 1990, after reforms lowered the top rate to 28 percent and eliminated many tax shelters, the revenue generated was equal to 8.1 percent of GDP.
It's bad economic policy to allow politicians to direct economic activity via tax breaks because loopholes often encourage people to spend money in less beneficial and economically productive ways than would otherwise occur. It's a process that also favors the well-connected over working families.
We saw that in Oklahoma with two incentive programs for small business and rural venture capital. In 2006, citizens learned those programs were allowing investors to obtain $2 in state tax credits for every $1 invested; the investors were guaranteed a profit even if the business failed. Those programs were effectively funneling hard-earned income from the pockets of Oklahoma's working families to the accounts of “investors” whose expertise was tax avoidance more than job creation.
Obama's tax-hike designs will likely have the same outcome, giving us a higher-rate tax code doing little to reduce deficits or debt, but empowering politicians to reward the politically connected in ways that distort the free market and impede economic growth.