Filing Taxes with an Economist

Frustrated with filing your tax return this year? You're not alone. Scott Sumner recently finished filing his tax return, and offered his thoughts on how to make the process smarter, more fair, and less painful.

As you’ve noted, filing income taxes can be expensive, stressful, and complicated, but filing payroll taxes isn’t something that most Americans ever notice. Why is there such a difference in how we collect different taxes?

The big problem is with the income tax. Back in 1913, we erroneously decided that income was the correct way of measuring economic well-being, and that those with higher incomes should pay more taxes. It is true that the wealthy should pay more taxes, but income is not a good measure of economic well-being. My taxable income tripled in 2017, but I was no better off than in 2016. (I sold a home, and bought an equally valuable home elsewhere. That transaction did not make me better off.) The other taxes are simpler to collect, and involve far less complexity. And payroll taxes are not just simpler than income taxes; wage income actually better reflects economic well-being. Although the current payroll tax system is regressive, it could easily be made progressive.

Some policy analysts and commentators have suggested reducing the tax filing burden by shifting the responsibility to the IRS entirely (called “return-free filing”). Do you see value in that approach?

Yes, that's done in some other countries and I believe that is the only ethical approach. The income tax system is far too complex for even a PhD economist to figure out. The government should not put the burden of computing taxes on individual taxpayers, as they cannot be expected to understand the tax code. I have found that even many professional tax preparers are not up to the task.

In some ways, internet-based tax preparation services (e.g. TurboTax) have improved the average taxpayer’s experience. Is that a long-term answer to America’s tax-filing woes?

TurboTax works for some people, but not others. The best solution would be to replace the income tax with a progressive consumption tax system. This might involve a progressive payroll tax, plus a progressive property tax system, plus a VAT that rebates the tax on the first $10,000 in consumption. At a minimum, the income tax should be simplified so that taxpayers do not need to use TurboTax.

You, and other economists, have argued that consumption is a better measure than income of how well off a person is, and therefore would make a better basis for a progressive system of taxation. Why is that?

You can think of income as measuring what we contribute to a society, and consumption as what we take from society. Viewed from that perspective, consumption is the obvious choice for a tax base. Individuals can do one of three things with income—consume it, invest it, or give it away to charity. If we end up taxing the part of income that is invested or given to charity, then someone other than the taxpayer ultimately bears the burden of the tax, in terms of lower living standards. Imposing a higher income tax on Warren Buffett is unlikely to lead him to consume less; instead, he'll either invest less in businesses that create jobs, or donate less to charity. If we want to make the wealthy assume a larger share of the tax burden, the only reliable way to do that is by taxing their consumption.

Short of completely rewriting the entire tax code, is there any room for short-term policy reforms that make the filing process more efficient or less costly for taxpayers?

The recent tax bill did make things slightly simpler by having fewer people pay the Alternative Minimum Tax, and leading to more people taking the standard deduction. Further reforms in that direction, such as eliminating the AMT and limiting deductions even further, would make the tax code simpler for average people. We could also eliminate the various phase-outs of deductions, and make up the lost revenue with slightly higher tax rates. Another easy reform would be to eliminate taxes on the first $50,000 in investment income from firms that the taxpayer does not work for. (That restriction would prevent people from hiding wage income as investment income.) For most people, taxes look like the following: wage income minus standard deduction equals taxable income, then look up taxes in the tax table.