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The current Internal Revenue Tax Code for the United States is too complicated for many people to understand and must be reformed and simplified. Most people do not understand the current method of figuring income tax, and they end up paying someone else to complete their annual income tax returns. Robert E. Hall and Alvin Rabushka, economists at Stanford University, state that, "since the Internal Revenue Service estimates that college level reading ability is required to obtain 90 percent comprehension of the instructions for preparing Form 1040-A, it is not surprising that over 6 million taxpayers paid commercial firms to complete even this simplified return" (3). The original two page tax form and two pages of instructions, passed by the Sixteenth Amendment to the Constitution in 1913, has become 54 pages of forms and over 6,000 pages of instructions (2).

Theodore J. Forstmann and Stephen Moore confirm the original tax form and instructions published in 1913 were printed on one page of the New York Times (44). In 1913, there were 3,000 employees at the Internal Revenue Service. Today, there are over 115,000 Internal Revenue Service employees (44). The Internal Revenue Service employs more people than the Environmental Protection Agency, the Occupational Safety and Health Administration, the Federal Bureau of Investigation, the Drug Enforcement Agency, the Food and Drug Administration, and the Bureau of Alcohol, Tobacco, and Firearms, combined!

The complexity of the current tax code was revealed in a recent study which showed over 8.5 million taxpayers seeking answers and assistance from the Internal Revenue Service by telephone received the wrong answer (Forstmann, and Moore 44). In 1990, the Internal Revenue Service issued more than 16,000 tax liens in error, and a 1994 report on the performance of the Internal Revenue Service stated that "the IRS fails to meet the standards of financial accountability and diligence that it imposes on the citizenry" (44). Because of complicated tax forms, confusing instructions, and misunderstandings, many people do not trust the Internal Revenue Service nor its agents. Everyone agrees the current tax code must be reformed and simplified. However, the question is which type of reform should be enacted by congress. Two suggestions for tax reform are the flat tax, proposed by Representative Richard Armey (R-Texas), and the consumption tax. The consumption tax could take the form of a national sales tax or a value-added tax.

It is not surprising that Congress would propose a national sales tax since most Americans understand and are familiar with sales tax. John L. Mikesell confirms that forty-five states plus the District of Columbia levy some type of sales tax (152). Unlike the current tax code, a national sales tax would not double-tax some types of earnings, such as dividend or interest income. Because interest and dividend incomes would be exempt from the tax base, advocates for the national sales tax claim the growth in savings and investments could give a boost to the economy.

Although a national sales tax would be easy to understand by the public, there are significant drawbacks to the plan. The first and foremost is the rate which would be required to meet current income tax levels. In 1995, individual income tax produced over $590 billion and corporate income tax produced over $157 billion. To match this income tax level, the national sales tax rate would have to be 25% or higher (Mikesell 160). At this high rate, compliance becomes a problem in the form of tax evasion. In many cases, the penalty for evasion would not encourage payment of the tax.

Most opponents to the national sales tax contend the impact on middle and lower income families would have a negative effect on the economy. Ronald Roach notes that "such taxes pose a greater burden on middle and lower income families because they have to devote a higher percentage of their income to buying basic goods and services than do wealthier families" (86). Because goods and services would become more expensive with the added national sales tax, middle to lower income families would likely reduce their purchases. This would especially effect the mass merchant retailers who target middle to lower income households (86).

Implementing and enforcing the national sales tax could cause conflict between federal and state governments. Mikesell concludes "a separate national retail sales tax would complicate the work of state tax collection, increase the problems that businesses face in complying with multiple tax bases, and tax on a base not equal to household consumption" (162). He also states that "vendors, the gatekeepers in any retail sales tax, would have to sort purchases as to taxability between the state and federal systems . . ." (160). Any mistake in computing local or state sales tax would result in mistakes in computing national sales tax also. The question arises as to which governing entity would audit and enforce compliance by businesses. The prospect of dual auditing and compliance would be a business nightmare.

The value-added tax is a consumption tax like the national sales tax; however, the difference is in the collection method. The national sales tax would be collected directly from the consumer at the time of final purchase, whereas the value-added tax would be collected from businesses based on production. Most proponents of a consumption tax favor the value-added tax because enforcement would be much easier than the national sales tax. Businesses would report to the Internal Revenue Service all sales, whether to other businesses or the final consumer; however, they would deduct any purchases which went into the product. For example, General Motors would report the sale of all vehicles sold to dealerships and then deduct the cost of radios purchased from Delco, the cost of tires purchased from Goodyear, and so forth for all products purchased from another supplier. Reporting would be easy to enforce because sales between businesses could be tracked. Delco and Goodyear would have to report their sales to General Motors because General Motors would be deducting those amounts from their tax base. This method almost makes the reporting system self auditing.

The value-added tax is still considered to be a consumption tax, and many people believe a consumption tax is regressive. Since the tax would be added to the cost of the finished product, the price of everything would normally rise. William G. Gale believes the poor would be hurt by the value-added consumption tax because they must spend a greater percentage of their income on necessities (40). Jack M. Mintz also believes that lower income families will be hit hardest with a consumption tax. He explains that under the current tax code, many lower income families do not pay taxes; many even receive money in the form of Earned Income Credit (470). However, under a consumption tax, lower income families would have to pay taxes when they purchase goods and services. In the May, 1997 issue of The World & I, Joe Cobb, former chief economist for the Senate Republican Policy Committee, states, " . . . business does not pay taxes, only people do. Business just collects and sends tax money to the government."

Another major consideration to the value-added tax is the impact on businesses. The value-added tax would require businesses to keep extensive records to prove their purchases from other businesses. Capital expenditures would be excluded from the tax base so the current tax deduction of depreciation would be eliminated (Mintz 465). In 1993, corporations claimed $363 billion in depreciation deductions and unincorporated businesses claimed about one-third of that amount (Gale 43). Since many businesses have capital expenditures which have been partly depreciated, some type of transition would have to be enacted. The problem of verification and enforcement of the transition would arise since some businesses could try to misrepresent their depreciation schedules (43). In comparison to the current income tax system, the compliance, administration, and transition associated with both the national sales tax and the value-added tax would not be simple to implement (Mintz 473).

Representative Armey had proposed an income tax reform in the form of a flat tax. Jenny Wahl, correspondent for the Minneapolis Star Tribune, states that "the Armey bill replaces 1378 pages of tax code with a mere five pages. Taxpayers would file a 12-line individual form, a 10-line business form or both." Alan L. Feld further states, "For the general public, the . . . attraction of the flat tax lies in its promise of simplicity" (603).

Cobb explains that the Armey proposal would tax at a flat rate of 17%. Generous personal exemptions for the taxpayer, spouse, and dependents would do away with complicated deductions and tax loopholes. Jonathan Peterson, correspondent for the
Minneapolis Star Tribune, states that "many Americans view today's tax code as riddled with loopholes that benefit people with high-priced lawyers and accountants." Peterson calculated that under the current tax system, loopholes reduced the tax collection by over $1.3 trillion in 1993 which represented almost 50% of the tax base, and eliminating all the loopholes could reduce the flat tax rate as low as 13.5% for individual tax returns. Feld believes that for most of the public, the prospect of filing a complete income tax return on a form the size of a postcard has won their support (603).

The personal exemptions allowed under Armey's proposal would protect lower income families from tax burdens much as the current tax system protects lower income families. By eliminating deductions and taxing income at a flat rate, employers could deduct the tax from each paycheck and submit that money to the Internal Revenue Service. This is the current system today, but with the flat tax rate, there would be no complicated forms at the end of the year. With such simplification, the Internal Revenue Service could be reduced. There would be no need for time consuming tax audits nor the need for citizens and taxpayers to endure rude and intimidating tax auditors. Armey states that "according to the Tax Foundation, the flat tax would reduce compliance costs by 94 percent" (8).

Armey's proposal would be easy to implement and manage since the tax codes and the Internal Revenue Service are already in place. Instead of rewriting the entire tax code, Armey's proposal would revise and simplify the current system. Rewriting the entire tax code would become a congressional nightmare. The largest private industry in Washington, D.C. is the lobbying and special interest groups with over 67,000 people working in these groups, and their number one lobby issue is the income tax code (Armey 7).

Any changes to the current income tax code should meet two tests to be considered a rational tax code (Forstmann, and Moore 52). The first test is that ordinary citizens must be able to function under the tax system even if they are neither lawyers nor certified public accountants. The second test is that the system must be simple enough that taxpayers can easily compute the amount of tax they owe (52).

Congress is receiving public pressure to reform the current tax structure. The flat tax proposal by Representative Armey would be simple to understand and easy to enforce. It would not put a burden on the Internal Revenue Service in conversion procedures, and compliance costs would be greatly reduced. More importantly, the public would understand the tax system. With this understanding, perhaps trust in the government and trust in the Internal Revenue Service could begin. If adopted by Congress, Forstmann and Moore said it best for everyone, "We would add one special request to Congress: please stop this reckless behavior of monkeying around with the tax system year after year" (51).









			Debbie L. Grant English 1302.33 18 November 1999 Income Tax Reform: Flat Tax versus Consumption Tax The current Internal Revenue Tax Code for the United States is too complicated for many people to understand and must be reformed and simplified. Most people do not understand the current method of figuring income tax, and they end up paying someone else to complete their annual income tax returns. Robert E. Hall and Alvin Rabushka, economists at Stanford University, state that, "since the Internal Revenue Service estimates that college level reading ability is required to obtain 90 percent comprehension of the instructions for preparing Form 1040-A, it is not surprising that over 6 million taxpayers paid commercial firms to complete even this simplified return" (3). The original two page tax form and two pages of instructions, passed by the Sixteenth Amendment to the Constitution in 1913, has become 54 pages of forms and over 6,000 pages of instructions (2). Theodore J. Forstmann and Stephen Moore confirm the original tax form and instructions published in 1913 were printed on one page of the New York Times (44). In 1913, there were 3,000 employees at the Internal Revenue Service. Today, there are over 115,000 Internal Revenue Service employees (44). The Internal Revenue Service employs more people than the Environmental Protection Agency, the Occupational Safety and Health Administration, the Federal Bureau of Investigation, the Drug Enforcement Agency, the Food and Drug Administration, and the Bureau of Alcohol, Tobacco, and Firearms, combined! The complexity of the current tax code was revealed in a recent study which showed over 8.5 million taxpayers seeking answers and assistance from the Internal Revenue Service by telephone received the wrong answer (Forstmann, and Moore 44). In 1990, the Internal Revenue Service issued more than 16,000 tax liens in error, and a 1994 report on the performance of the Internal Revenue Service stated that "the IRS fails to meet the standards of financial accountability and diligence that it imposes on the citizenry" (44). Because of complicated tax forms, confusing instructions, and misunderstandings, many people do not trust the Internal Revenue Service nor its agents. Everyone agrees the current tax code must be reformed and simplified. However, the question is which type of reform should be enacted by congress. Two suggestions for tax reform are the flat tax, proposed by Representative Richard Armey (R-Texas), and the consumption tax. The consumption tax could take the form of a national sales tax or a value-added tax. It is not surprising that Congress would propose a national sales tax since most Americans understand and are familiar with sales tax. John L. Mikesell confirms that forty-five states plus the District of Columbia levy some type of sales tax (152). Unlike the current tax code, a national sales tax would not double-tax some types of earnings, such as dividend or interest income. Because interest and dividend incomes would be exempt from the tax base, advocates for the national sales tax claim the growth in savings and investments could give a boost to the economy. Although a national sales tax would be easy to understand by the public, there are significant drawbacks to the plan. The first and foremost is the rate which would be required to meet current income tax levels. In 1995, individual income tax produced over $590 billion and corporate income tax produced over $157 billion. To match this income tax level, the national sales tax rate would have to be 25% or higher (Mikesell 160). At this high rate, compliance becomes a problem in the form of tax evasion. In many cases, the penalty for evasion would not encourage payment of the tax. Most opponents to the national sales tax contend the impact on middle and lower income families would have a negative effect on the economy. Ronald Roach notes that "such taxes pose a greater burden on middle and lower income families because they have to devote a higher percentage of their income to buying basic goods and services than do wealthier families" (86). Because goods and services would become more expensive with the added national sales tax, middle to lower income families would likely reduce their purchases. This would especially effect the mass merchant retailers who target middle to lower income households (86). Implementing and enforcing the national sales tax could cause conflict between federal and state governments. Mikesell concludes "a separate national retail sales tax would complicate the work of state tax collection, increase the problems that businesses face in complying with multiple tax bases, and tax on a base not equal to household consumption" (162). He also states that "vendors, the gatekeepers in any retail sales tax, would have to sort purchases as to taxability between the state and federal systems . . ." (160). Any mistake in computing local or state sales tax would result in mistakes in computing national sales tax also. The question arises as to which governing entity would audit and enforce compliance by businesses. The prospect of dual auditing and compliance would be a business nightmare. The value-added tax is a consumption tax like the national sales tax; however, the difference is in the collection method. The national sales tax would be collected directly from the consumer at the time of final purchase, whereas the value-added tax would be collected from businesses based on production. Most proponents of a consumption tax favor the value-added tax because enforcement would be much easier than the national sales tax. Businesses would report to the Internal Revenue Service all sales, whether to other businesses or the final consumer; however, they would deduct any purchases which went into the product. For example, General Motors would report the sale of all vehicles sold to dealerships and then deduct the cost of radios purchased from Delco, the cost of tires purchased from Goodyear, and so forth for all products purchased from another supplier. Reporting would be easy to enforce because sales between businesses could be tracked. Delco and Goodyear would have to report their sales to General Motors because General Motors would be deducting those amounts from their tax base. This method almost makes the reporting system self auditing. The value-added tax is still considered to be a consumption tax, and many people believe a consumption tax is regressive. Since the tax would be added to the cost of the finished product, the price of everything would normally rise. William G. Gale believes the poor would be hurt by the value-added consumption tax because they must spend a greater percentage of their income on necessities (40). Jack M. Mintz also believes that lower income families will be hit hardest with a consumption tax. He explains that under the current tax code, many lower income families do not pay taxes; many even receive money in the form of Earned Income Credit (470). However, under a consumption tax, lower income families would have to pay taxes when they purchase goods and services. In the May, 1997 issue of The World & I, Joe Cobb, former chief economist for the Senate Republican Policy Committee, states, " . . . business does not pay taxes, only people do. Business just collects and sends tax money to the government." Another major consideration to the value-added tax is the impact on businesses. The value-added tax would require businesses to keep extensive records to prove their purchases from other businesses. Capital expenditures would be excluded from the tax base so the current tax deduction of depreciation would be eliminated (Mintz 465). In 1993, corporations claimed $363 billion in depreciation deductions and unincorporated businesses claimed about one-third of that amount (Gale 43). Since many businesses have capital expenditures which have been partly depreciated, some type of transition would have to be enacted. The problem of verification and enforcement of the transition would arise since some businesses could try to misrepresent their depreciation schedules (43). In comparison to the current income tax system, the compliance, administration, and transition associated with both the national sales tax and the value-added tax would not be simple to implement (Mintz 473). Representative Armey had proposed an income tax reform in the form of a flat tax. Jenny Wahl, correspondent for the Minneapolis Star Tribune, states that "the Armey bill replaces 1378 pages of tax code with a mere five pages. Taxpayers would file a 12-line individual form, a 10-line business form or both." Alan L. Feld further states, "For the general public, the . . . attraction of the flat tax lies in its promise of simplicity" (603). Cobb explains that the Armey proposal would tax at a flat rate of 17%. Generous personal exemptions for the taxpayer, spouse, and dependents would do away with complicated deductions and tax loopholes. Jonathan Peterson, correspondent for the Minneapolis Star Tribune, states that "many Americans view today's tax code as riddled with loopholes that benefit people with high-priced lawyers and accountants." Peterson calculated that under the current tax system, loopholes reduced the tax collection by over $1.3 trillion in 1993 which represented almost 50% of the tax base, and eliminating all the loopholes could reduce the flat tax rate as low as 13.5% for individual tax returns. Feld believes that for most of the public, the prospect of filing a complete income tax return on a form the size of a postcard has won their support (603). The personal exemptions allowed under Armey's proposal would protect lower income families from tax burdens much as the current tax system protects lower income families. By eliminating deductions and taxing income at a flat rate, employers could deduct the tax from each paycheck and submit that money to the Internal Revenue Service. This is the current system today, but with the flat tax rate, there would be no complicated forms at the end of the year. With such simplification, the Internal Revenue Service could be reduced. There would be no need for time consuming tax audits nor the need for citizens and taxpayers to endure rude and intimidating tax auditors. Armey states that "according to the Tax Foundation, the flat tax would reduce compliance costs by 94 percent" (8). Armey's proposal would be easy to implement and manage since the tax codes and the Internal Revenue Service are already in place. Instead of rewriting the entire tax code, Armey's proposal would revise and simplify the current system. Rewriting the entire tax code would become a congressional nightmare. The largest private industry in Washington, D.C. is the lobbying and special interest groups with over 67,000 people working in these groups, and their number one lobby issue is the income tax code (Armey 7). Any changes to the current income tax code should meet two tests to be considered a rational tax code (Forstmann, and Moore 52). The first test is that ordinary citizens must be able to function under the tax system even if they are neither lawyers nor certified public accountants. The second test is that the system must be simple enough that taxpayers can easily compute the amount of tax they owe (52). Congress is receiving public pressure to reform the current tax structure. The flat tax proposal by Representative Armey would be simple to understand and easy to enforce. It would not put a burden on the Internal Revenue Service in conversion procedures, and compliance costs would be greatly reduced. More importantly, the public would understand the tax system. With this understanding, perhaps trust in the government and trust in the Internal Revenue Service could begin. If adopted by Congress, Forstmann and Moore said it best for everyone, "We would add one special request to Congress: please stop this reckless behavior of monkeying around with the tax system year after year" (51). Works Cited Armey, Dick. "The 1998 Tax Reform Debate: The Flat Tax: Restoring Freedom and Fairness to Federal Taxation." National Public Accountant 43.1 (Jan./Feb. 1998): 7-8. Cobb, Joe. "The Flat Tax." The World & I 1 May 1997: 28. Feld, Alan L. "Living with the Flat Tax." National Tax Journal 48.4 (Dec. 1995): 603-617. Forstmann, Theodore J., and Stephen Moore. "Abolish the Tax Code Not the IRS." Chief Executive May 1998: 44-52. Gale, William G. "Simple, Efficient, Fair. Or Is It?" Brookings Review 16.3 (Summer 1998): 40-44. Hall, Robert E., and Alvin Rabushka. Low Tax Simple Tax Flat Tax. New York: McGraw-Hill Co., 1983. Mikesell, John L. "The American Retail Sales Tax: Considerations on Their Structure, Operations, and Potential as a Foundation for a Federal Sales Tax." National Tax Journal 50.1 (Mar. 1997): 149-165. Mintz, Jack M. "The Thorny Problem of Implementing New Consumption Taxes." National Tax Journal 49.3 (Sep. 1996): 461-474. Peterson, Jonathan. "Flat Tax: Has Its Day Arrived?" Minneapolis Star Tribune 28 Sep.1995: 4A. Roach, Ronald. "Key Reform Plans Back Shift from Income to Consumption Tax." Stores May 1998: 84-86. Whal, Jenny. "Surprise for Those Who Think a Flat Tax Would Be Simpler." Minneapolis Star Tribune 11 March 1996: 3D.