The current wrangling over the alternative minimum tax is a symptom of the larger problems with having a Tax Code built on patchwork over nearly a century, to the point that it resembles a Rube Goldberg contraption, according to David A. Lifson, president of the New York State Society of CPAs and a co-managing partner at New York-based Hays & Co. LLP.Lifson, who recently testified before the Select Revenue Measures Subcommittee of the House Ways and Means Committee on the AMT, also chaired the NYSSCPA Committee on Tax Reform that issued a comprehensive proposal to revise the current tax system.

The proposal, named the Simplified Exact Transparent Tax, or SET Tax, would tax all incomes over a threshold established by political leaders, reduced by government-approved exclusions, at an economically appropriate and socially acceptable rate.

"The SET Tax is designed to organize 94 years of patches to the Internal Revenue Code," Lifson explained.

In today's system, if you make under a certain amount you don't have to report it, which eliminates many taxpayers that make all their income in cash, according to Lifson. Under the SET Tax, "If you really didn't make enough to file, you still write it down and tell the government and send it in."

The proposal, the result of months of work by a committee that he chaired, retains the best aspects of the current Tax Code, eliminates its worst aspects and adds new benefits, according to Lifson. "The people on the committee ranged from libertarians on the right to raging liberals on the left," he said. "So we came up with a proposal that retains current progressivity but with a simpler and transparent means to get there."

"The income tax is in many respects the tax of last resort, in that we have a patchwork of dozens of other taxes that everyone in the country pays every day, including sales tax, excise tax, property taxes, and the Medicare and Social Security tax. So the income tax, especially the federal income tax, was really designed as the tax of last resort to tax our citizens who are the most successful," he said.

"Roughly half of Americans pay income tax and roughly half don't," Lifson observed. "So, in order to get people that are well off to pay income tax and not scream at the inequities, a fundamental concept is that we only tax net income, not gross income, and we would only do so based on everybody's ability to pay. One of the original concepts in determining someone's ability to pay is they take someone's gross income and deduct most of the taxes that are paid to state and local governments, reduced from income to figure out what your ability to pay is."

A GLARING EXAMPLE

For historically obscure design reasons, the AMT violated this concept. "Originally the violation was subtle," he said. "But what happened over time is that all the tax breaks that they were trying to tax were removed, and what was left in was state and local taxes and large families. That's how we got into the mess that we're in today."

"The AMT is just a glaring example of a million patches to the code," explained Lifson. "Each patch, each change, each tweak was well-intended and well-designed. If you were to evaluate each element of the Internal Revenue Code individually, you could find some good in it, but when you try to organize all those good notes, today's symphony produces pure cacophony. It makes more noise than sense."

But there's still some hope, according to Lifson. "Frankly, since it's built on such good notes, all it needs is a good conductor to organize it," he said. "You have to come up with a better way to say the same thing."

That's exactly what the SET Tax would do, he said. "The SET Tax is a transparent way to see the impact of social and tax policy decisions made by Congress. These decisions are currently often opaquely buried in the tax system," Lifson said.

The current system achieves progressivity through requiring a progressive tax rate, making lawmakers' position on fiscal policy and tax planning unclear. The SET Tax accomplishes progressivity by using a single tax rate on all gross income and then allowing straightforward subtractions defined by Congress, such as mortgage interest, state taxes, charitable contributions and a portion of long-term capital gains.

Under the SET Tax, Lifson said, nobody's bill would change, but the code itself would be greatly simplified.

"If you were to actually do the math of a current tax calculation, it would involve thousands of lines of code just to calculate it," he said. "But if you reduce that code into its simplest form, you could rewrite the entire Internal Revenue Code without changing any U.S. citizen's tax bill."

"No law-abiding person who paid tax before would have their tax bill changed," he said. "The only persons whose tax would change under this system would be people that are not paying the taxes they owe, who would be so afraid of discovery they would start paying."

For example, if you're a single taxpayer with current income of $336,550, your income tax under 2006 numbers is $97,653, explained Lifson. "The SET subtraction is $57,542. This makes taxable income $27,900, which at a rate of 35 percent comes to exactly the same amount."

The trick is to design the subtractions so that decreasing amounts of income are excluded from tax at a single rate, which mathematically is identical to having rate bands, said Lifson. "When the income tax was first designed, they wanted to make it easy for people to understand what their taxes were. Having rate bands was a good way to communicate this when there was nothing else to think about. But nearly 100 years later there's a lot of stuff to think about and it doesn't work very well."

"We will never be able to make taxes simple for people who engage in complex economic activity, but we can make them simpler to understand. By having a list of subtractions, people can focus only on the topics that matter to them," he said.

"Half the people in the U.S. will be able to focus only on the standard subtraction, and will once a year write down or transmit electronically how much they made and that they owe no tax," he continued. "Today they just think they don't owe anything, but no one's sure because the system is so complex. The other half will have the slightly more complex job of adding all their subtractions, mortgage interest, charitable contributions and maybe a subtraction from a spouse that didn't earn a lot of money - there won't be a joint return - and figuring their tax based on SET."

The SET Tax works equally well for corporations and other entities, explained Lifson. "It doesn't change who is taxed. It just makes it transparent - easier to pay, understand, collect and administer."

The act of annual compliance would drive people to a higher moral standard by creating a culture of compliance, one of the additional benefits of having such a system. "Closing the tax gap by just one-third would make it possible to eliminate the AMT," he said. "We think it's worth a try."

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