Navigating the Landscape of Individual Tax Reform

Navigating the Landscape of Individual Tax Reform

When the ink dried on the personal income tax legislation in 1913, a mere 0.5% of the population found themselves entangled in the web of individual tax returns. Fast forward to the present, and almost half of the population is immersed in the intricate dance of individual tax returns, with personal income tax emerging as the primary revenue stream for the federal government.

According to the Joint Committee on Taxation's insights in the 'Overview of the Federal Tax System As In Effect for 2017,' individual income tax is projected to constitute a significant 48.5% of federal receipts in 2017. The Trump Administration has unveiled its proposal for Individual Tax Reform, centered on three key pillars:

  • Reduction of Tax Brackets: The plan suggests streamlining the seven existing tax brackets into three, specifically at 12%, 25%, and 35%.
  • Standard Deduction Doubling: Doubling the standard deduction is proposed, aiming to simplify tax calculations and reduce the need for itemizing deductions.
  • Tax Relief for Families: A focus on providing tax relief for families grappling with child and dependent care expenses.

What's intriguing is the historical echo in this proposed reform. Over a century ago, when the personal income tax made its debut, it featured seven distinct tax brackets. Additionally, the government incorporated various tax expenditures, including the home mortgage interest deduction, deductions for state and local taxes, and the exclusion of interest on government bonds.

While the structure of the individual income tax has endured across the decades, the accompanying instructions have experienced a meteoric expansion. In 1913, Form 1040 was accompanied by a mere two pages of instructions. Today, the individual income tax labyrinth comes with over 200 pages of instructions and nearly 200 supplemental forms.

Reducing the number of tax brackets from 7 to 3 promises a simpler system, reminiscent of its 1913 counterpart, but it raises concerns about progressivity. Simplification could potentially result in a less progressive tax system, meaning the federal government might collect less revenue over a 10-year budget window.

Doubling the standard deduction injects a dose of simplicity into the tax calculation. A doubled standard deduction implies a reduced need for itemizing deductions, leading to a more straightforward tax form. Moreover, this move renders more taxpayers exempt from the individual income tax. If, for instance, the standard deduction increases to $24,000 for a married couple, the couple could earn up to this amount before being subject to federal income tax.

This, however, is merely the tip of the iceberg. With additional tax benefits potentially available—expanded child tax credits, Earned Income Tax Credit (EITC), and a new credit for non-child dependents—a couple could find themselves earning significantly more than $24,000 before facing federal income taxes.

As the Administration charts the course for its tax plan, a critical evaluation of the long-term implications is essential. Implementing new tax expenditures alongside reductions in tax rates requires a meticulous balancing act, ensuring the government can sustain its revenue intake.

Amidst the nearly 200 IRS forms tethered to the individual tax return, it is undeniable that our system is ripe for reform. The challenge, however, lies in striking a balance between the advantages of heightened simplicity and the revenue decrease typically associated with rate cuts and provisions that dilute progressivity.

This challenge mandates compromise from both the chambers of Congress and the White House, underscoring the intricate negotiations ahead. Without compromise, the pursuit of a revenue-neutral tax reform package will be an uphill battle. As the wheels of tax reform set in motion, the nation braces for a transformation that will shape the financial landscape for generations to come.

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