Although tax experts from across the spectrum predict that a real tax reform is in our future, they are divided on how soon it will happen or what form it will take.Mark Weinberger, former Treasury assistant secretary for tax policy, said during a recent Tax Analysts-sponsored Webcast that tax reform will eventually happen. However, said Weinberger, currently Americas vice chair for tax services for Ernst & Young, the structure and timing are still up in the air.
Meanwhile, a new study indicates that the real obstacle to tax reform may not be the army of Washington lobbyists who fight to protect various deductions and exemptions, but the fact that the country is divided between a growing class of people who pay no income taxes and a shrinking class of people who bear the lion's share of the burden, according to Tax Foundation president and economist Scott A. Hodge.
In the group's annual Survey of U.S. Attitudes on Taxes and Wealth, conducted by Harris Interactive, Hodge concluded that the time is ripe to overhaul the federal tax code. "A majority of American adults believe federal taxes are too high, the tax code is too complex, and the income tax system is unfair," he said. "A majority support simplification, even if it means giving up the deductions and exemptions they now enjoy."
However, Hodge believes, "The most serious obstacle to reform is the fact that America has become divided between a growing class of people who pay no income taxes and a shrinking class of people who are bearing the lion's share of the burden."
Income disparity between rich and poor can be attributed to the explosive growth in the number of single taxpayers and single-parent households during the last four decades, resulting in increasing the numbers in lower-income groups and pushing married couples into higher-income groups, according to the study.
It found that the bottom 20 percent of taxpayers is comprised of 84 percent single taxpayers, with just 16 percent married. On the other hand, the figures are reversed for the group at the top 20 percent of taxpayers: 86 percent are married, while only 14 percent are single. "Many of these high-income married couples are simply dual-income," said Hodge. "It's easy to see that with two incomes, working couples appear twice as wealthy as single individuals."
The study showed that the statistical middle range of taxpayers contains a majority of either single individuals or single parents with children. This contrasts with the stereotypical conception of a middle-class person of an intact family with children, not a single male in his first job out of college.
In addition to a division between single and married taxpayers, America is also becoming divided between those who pay income tax and those who pay no income tax, according to Hodge. "Many of the tax cuts enacted over the past four years - specifically the doubling of the child credit to $1,000 and the introduction of the new 10 percent bracket - were targeted to help taxpayers in the statistical middle class," he said. "It is unlikely that lawmakers understood how powerful these measures would be - not only lowering the tax burden for millions of lower- and middle-income taxpayers, but knocking millions of people off the tax rolls entirely - turning them into non-paying tax filers."
Tax Foundation economists estimated that in 2004, some 42.5 million Americans, one-third of all filers, had no tax liability after filing a return and taking advantage of their credits and deductions. This is nearly a 50 percent increase in the number of non-payers since 2000, and a 160 percent increase in the number of non-payers since 1985, according to Hodge.
Moreover, Hodge estimates that roughly 15 million more individuals and families earned some income in 2004, but not enough to require filing a return. These non-filers, added to the non-payers, comprise 57.5 million income-earning households that paid no income taxes last year.
Since one tax return often represents several people, he estimates that by including dependents, there are 120 million Americans, or 40 percent of the population, outside of the federal income tax system.
"I don't think anyone fully appreciates how our demographic changes affect the overall tax burden on different groups," said Hodge. "In particular, the Baby Boom generation has reached its peak earning years, so you have a huge cohort of middle- to upper-income Americans moving through the population and all are paying higher income tax rates. In contrast to the Generation Xers, they look on paper to be considerably wealthier just because of where they are in life."
Hodge believes that now that Baby Boomers are entering their peak earning years and pre-retirement years, they are affecting the perception that the rich are getting richer and the poor are getting poorer. "It's based on a snapshot of people at a point in time."
The apparent growing gulf between taxpayers and those who pay no income tax both impedes fundamental tax reform, and creates a need for it, said Hodge.
"In terms of an impediment, it poses reformers with a dilemma - if you expand the tax base, you inevitably raise taxes on millions who pay little or no income tax today, and if you lower tax rates, which is also the goal of tax reform, you 'cut taxes for the rich,' and none of these outcomes is politically saleable at this time."
George Pieler, former tax counsel to the Senate Finance Committee and a scholar with the Lewisville, Tex.-based Institute for Policy Innovation, agreed. "We all benefit equally from national defense and other federal programs," he said. "To the extent that people pay even a token toward shouldering the burden, it makes them feel invested in the system."
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