Four ways to simplify the income tax
As millions of Americans sit down to prepare their income tax returns, a recent survey suggests that this activity is driving people to tears and to therapists. Despite the widespread desire across the political spectrum for simplicity, the tax code keeps getting more complicated.
It does not need to be this way. Congress could take concrete steps to simplify taxes for all Americans. In a new project from the Brookings-Urban Tax Policy Center, we lay out four proposals that simplify the income tax code, don’t add to the government’s debt and make the tax system less punishing for low- and middle-income households.
The key to simplification is, put plainly, to cut down on complexity. Policymakers should remove targeted provisions and tax everything at the same rate, while still helping those who need it most. Congress has several options for doing so. Lawmakers can eliminate itemized deductions. They are expensive, regressive and used by relatively few households since the 2017 tax act raised the standard deduction substantially.
They could also end all preferential tax rates — for capital gains, dividends and business income. These are generally regressive, meaning they help high-income Americans more than the middle class or poor. Preferential rates also create opportunities for sheltering and tax avoidance, which generate further complexity.
If Congress wanted to move further, it could remove the head of household filing status and standardize the definition of who counts as a child for tax purposes. Currently, there are four separate definitions of a “qualifying child” for different tax credits and filing statuses, each with their own complicated rules and significant penalties for getting it wrong.
Replacing the current “alphabet soup” of complex tax credits with credits that are simpler, broader and more easily administrable would also do some good. For example, current Earned Income Tax Credit rules stretch to 15 pages , which may explain why more than a fifth of eligible taxpayers do not claim the credit. Finally, changes to the system should replace existing credits with a personal credit for each family member and a work credit that depends on an individual’s earnings. That would ensure families still get support they need without encouraging Americans to not work.
With those changes in mind, our first proposal calls for a personal credit of $1,000 in cash for all Americans, regardless of income. If policymakers wanted to boost incomes for lower-income families with children, our second proposal shows that they could increase the benefit to $2,000 per person per year, but phase it out beginning at $72,000 of income for a married couple or $36,000 for a single filer.
If Congress wanted even simpler income taxes, they could create a value-added tax (VAT), a tax on goods and services used by every other developed country in the world, and use the revenue to pay for bigger reforms. In our third proposal, based on a pitch by Columbia University Professor Michael Graetz, VAT revenue would fund an increase in the standard deduction to $100,000 for married couples and $50,000 for single filers from its current values of $27,700 and $13,850, respectively. Almost two-thirds of Americans would not need to file taxes at all. It does not get any simpler than that.
Alternatively, our fourth proposal shows that VAT revenue could go towards providing a small universal basic income (UBI) of $3,900 per person per year. UBIs have received historical support from both the left and the right. This would lift the average after-tax income of families below the federal poverty line by more than 30 percent on average, effectively slashing poverty in America. It would also be revenue-neutral, paid for by the savings from simplification and the VAT.
Some of the most sweeping improvements can be implemented under any of the four proposals. The Treasury could pre-populate tax forms for most filers (as has been done in many other developed countries since the early 2000s), simplifying tax filing tremendously. And the IRS’s nascent direct-file system could be used for an even greater share of returns, saving taxpayers time and money.
Simplification is not an easy proposition. The tax code did not get complicated by accident, and the factors that generate complex tax systems—policy trade-offs, the complexity of families and businesses, the role of lobbyists, etc.—are not going away. Still, while everyone talks about simplification, policymakers now have four concrete proposals to choose from, all of which would make taxes (and life) simpler for many people.
William Gale is Senior Fellow and Samuel Thorpe is Senior Research Assistant at the Brookings Institution and the Urban-Brookings Tax Policy Center.