The FreedomTax would reform the entire system of taxation, modernize it, make it tax-efficient, and redesign the tax into a true income tax. This modernization would make the income tax no longer prone to the frequent ad hoc tax-law changes. The FreedomTax’s end to the universal filing of personal-tax returns, will mean that a future Congress no longer will have this as the easy vehicle to undo and mess-up the reforms made.
By James K. Jeanblanc l March 13, 2018
The tax-writing House Ways & Means Committee in session
The new Tax Cut and Jobs Act of 2017 has been hailed as “sweeping tax reform.” The euphoria is misplaced. Essentially, it’s a tax-cut measure. It leaves the tax system fully intact, un-reformed, still antiquated, and still inefficient. For now, the New Act cloaks some of the rough edges of the tax mess. But, the mess Congress created is still there, and it’s likely to grow noticeably worse, judging from the aftermath of the much-ballyhooed Tax Reform Act of 1986.
Some may feel that, along with all of the tax-reform proposals of the 2016 Presidential Election Cycle, the FreedomTax Plan is now passe. Not so. The New Act’s passage has strengthened the case for the FreedomTax, making it more convincing as the best plan to achieve real and lasting income-tax reform.
The New Act is a product of the tax-reform cycle, mapping an over-half-century story of Congressional income-tax reforms. As now structured, the federal income tax is a much-disliked tax. When public unhappiness reaches a high level, then it’s cycle-time for another tax reform.
The Act gives the cycle more color. None of the tax reforms so far enacted have been designed to break the cycle. No attempt has been made to reform the tax system itself. Instead, the tax rates and tax breaks get rejiggered and the system is allowed to continue functioning as a person-taxing system, with secondary focus on what’s supposed to be taxed – income.
The FreedomTax Plan would reform the entire system of taxation, modernize it, make it tax-efficient, and redesign the tax into a true income tax. This modernization would make the income tax no longer prone to the frequent ad hoc tax-law changes. More about the FreedomTax below, but first, three observations about the New Act:
1. The New Act Makes Tax Cuts Complicated. If tax simplification were the goal, the New Act would have restructured the tax system to have business income and personal income taxed at the same tax rates, to be followed by a general rate reduction. But, it cut the tax rate on business income (for corporations) much more than it cut the tax rates on personal income (taxed to individuals). Business income from pass-through entities (proprietorships, partnerships, LLCs, and subchapter S corporations) has always been taxed to the individual owners as personal income, often at higher rates than to corporations. By cutting the corporate tax rate more, the Act greatly widened that rate disparity.
This required the Act to add a new 20% income deduction to reduce the amount of the pass-through business income subject to taxation to individual taxpayers. The intent here is for them to be taxed on that business income at an effective tax rate closer to the rate at which a corporation would be taxed.
Alas, complexity begets complexity. Not all pass-through income is business income; some often is compensation income. So, the Act has added elaborate tax rules specifying what pass-through income qualifies as “business income” and is eligible for the new rate-lowering 20% deduction.
2. No Governing Principle of Taxation. The New Act is a grab-bag of special provisions mirroring the tax system itself. There exists no governing principle of what’s “income” or how it’s supposed to be taxed.
Following the lead of the system it’s not to reform, the Act reaffirms the system’s arbitrariness and even expands upon its use for purposes other than revenue-raising. There are two stand-out examples: The first is a provision in the Act to allow the full cost of investments to be “expensed,” this to spur business investment. The second limits the interest expense deduction for companies deemed to be too heavily indebted, this to discourage companies from taking on too much debt.
3. Tax-Targeting. The New Act continues the practice of targeting persons, rather than income, to raise revenue. It imposes a $10,000 cap on the itemized deductions for state and local taxes (“SALT”), to increase the taxes owed by high-income taxpayers.
The observation here is not to defend SALT deductions. These deductions, along with the many other tax breaks, are for expenditures having nothing to do with the generation of income. The system is a mess.
Key Features of the FreedomTax
There are three elements to the FreedomTax: First, it is governed by solid principle that all income must bear its fair share of the income tax. This means that all income would be taxed the same, and at the same rate, no exceptions.
Second, the income tax would be collected at the source of payment in the case of personal income – dividends, interest, salaries and wages, and retirement income. As a result, most people never will have to file an income tax return to report their income or have dealings with the IRS. For them, paying the income tax will be as simple as paying the gasoline tax at the pump.
And third, the so-called self-assessment system now used to collect the income tax, no longer would be required for individual taxpayers. Self-assessment has been the essential vehicle enabling the income tax to function as a person-taxing system. Every person in receipt of taxable income must report his income in a personal return, claim his personal tax breaks, and compute (using the tax-bracket rates applicable to him) his personal tax owed. The tax is assessed against him, not the income. Under this system, it’s rare to find any two persons paying the same effective tax rate on their income. The system is costly to administer, not compliance-easy, and highly inefficient in tax collection.
Lasting Reform. The FreedomTax’s end to the universal filing of personal-tax returns, will mean that a future Congress no longer will have this as the easy vehicle to undo and mess-up the reforms made. Moreover, the FreedomTax reforms are based on principle which is reflected in its redesign and restructuring of the tax system. This should make the FreedomTax reforms best positioned to resist the politics of personalized tax rates, added tax breaks, and tax-base erosion.
Real Reform. In restructuring the system into a true income-tax system, the FreedomTax will achieve: (1) breath-taking tax-simplification, greatly easing compliance burdens; (2) low-rate taxation, boosting after-tax returns from investments and from business ventures; (3) tax fairness, having all income bear its fair share of the income-tax burden; (4) tax-neutrality, ending market distortion and tax-driven decision-making; and (5) tax-efficiency, saving the Treasury billions in administration costs.
Much Better for Less Cost. The New Act is estimated to increase the Budget Deficit by more than $1 trillion over the next 10 years. However, the FreedomTax with its tax rate proposed at 10% is expected to raise at least as much revenue as the old tax system (before the New Act was passed) and, with official revenue-scoring, that 10% rate might be made 9% or even lower. So, the FreedomTax is a plan for something much better for less cost.
James K. Jeanblanc is tax counsel to the law firm, Grove, Jaskiewicz & Cobert in Washington, D.C. During the tax reform act of 1969, he was directly involved in the House-Senate drafting sessions. He is a graduate of the University of Illinois School of Law and received his LL.M. degree in Taxation from George Washington University. He is a former adjunct professor of law for the Tax Policy Seminar in the graduate law program of the Georgetown University Law School and has been a lecturer of law in the graduate law program of the George Washington University Law School. He is a former chairman of the Committee on Tax Accounting Problems of the Tax Section of the American Bar Association. Formerly, he was an attorney in the Office of the Tax Legislative, U.S. Treasury Department and an Assistant Branch Chief of the Corporate Tax Branch of the Legislation and Regulations Division of the Internal Revenue Service. He is the author of the FreedomTax and has a half-century of income tax experience involving tax legislation, tax regulation, IRS ruling, tax planning, and tax controversy matters. He is Senior Fellow for Tax Policy at the Selous Foundation for Public Policy Research and a contributor to SFPPR News & Analysis.