April 15 is a date that engenders much fear and loathing among taxpayers...and for good reason. The average American spent around thirteen hours preparing his or her tax return. Compliance costs alone drained an estimated $203.4 billion from the U.S. economy last year. Indeed, federal, state, and local taxes constitute such a large portion of the American economy that the average American spent the first 101 days of 2004 working just to pay the tax bill, according to the Tax Foundation. Thankfully, after last Sunday, April 11, taxpayers can keep what they earn for the rest of the year.
This is the silver lining of Tax Day 2004. April 11, this year's Tax Freedom Day, is the earliest date for this celebration since 1967. In 2000-just four years ago-Tax Freedom Day was May 2, the latest in the year that it has fallen since World War II. The tax cuts passed in 2001 and 2003, however, reversed the trend of rising tax burdens year after year and let Americans keep more of the money that they earn. These tax cuts still need to be made permanent, though, or Tax Freedom Day will shift in the wrong direction, back towards May. Unless Congress acts, the increased economic freedom that Americans now enjoy will soon be lost.
Four Steps to a Kinder, Gentler April 15
In addition to letting Americans keep more of their money, pro-growth tax changes helped trigger a strong recovery and pull the economy out of recession. Combined, these forces have made April 15 a little more palatable. But to defend against the return of tax tyranny, more must be done. Congress must hold the line against tax hikes while working to enact new reforms:
- Make the tax cuts of 2001 and 2003 permanent;
- Ensure American businesses can stay competitive in the international market by lowering the corporate tax rate-which now ranks among the highest in the world-and eliminating "worldwide" taxation;
- Exclude savings accounts from double taxation to help Americans better prepare for their retirements; and
- Fundamentally reform the tax code by immediately streamlining the Rube Goldberg-like process and eventually scrapping the whole thing for a simple, flat, and fair tax.
Make the 2001 and 2003 Tax Cuts Permanent
The Bush tax cuts are working. Tax relief has lowered the cost of capital and made existing enterprises more profitable and investment and expansion more attractive. As the economy continues to grow and expand, stronger job performance will undoubtedly follow. To ensure the strongest future growth Congress should make these tax cuts permanent.
Unless the tax cuts are made permanent:
- Average income tax rates will climb back to Clinton-era levels;
- The double tax on dividends will climb back to a maximum of nearly 40 percent;
- The double tax on capital gains will climb back to 20 percent;
- New capital purchases by small and medium sized businesses will be subject to higher taxes;
- The federal estate tax, scheduled to die a long deserved death in 2010, would rise again like the phoenix;
- The child tax credit will fall by $300 dollars;
- Many of the worst "marriage penalties" in the old tax code will come back to life; and
- The expanded 10 percent tax rate-which cuts taxes for all taxpayers-would be lost.
Keep American Business Competitive in the World
The United States has one of the highest corporate tax rates in the world, second only to Japan's. America's corporate tax rate is higher than the rate in every European nation-even those of socialist welfare states like France and Sweden. This creates a significant competitive disadvantage for U.S.-based companies. As the CBO recently concluded, "Marginal tax rates (the tax rate on another increment of income) are the rates critical to influencing growth and efficiency." The corporate tax rate should be reduced.
The greedy hand of the Internal Revenue Service also reaches out to tax labor income, capital income, and corporate income earned in other nations-even though this income already is subject to foreign tax. This "worldwide" taxation places U.S. companies at a competitive disadvantage, reducing their share of the global market. Some argue that worldwide taxation is a good idea because it discourages U.S. companies from operating abroad, but this policy neither limits competition from factories in low-tax countries nor restricts imports. Instead, it impedes U.S. companies' ability to capture larger shares of foreign markets, which means fewer exports from the U.S. and fewer jobs. Territorial taxation-taxing only income earned inside national borders-is good tax policy, and reducing the tax burden on foreign-source income is a simple step in this direction that would help the U.S. economy, U.S. companies, and U.S. workers.
Don't Double-Tax Saving
People should not be taxed twice on income that is saved and invested, which is why individual retirement accounts should be universal. The President's proposed changes to the retirement account tax code would establish Lifetime Savings Accounts and Retirement Savings Accounts, both of which would work like expanded Roth IRAs. Although these accounts would increase short-term tax revenue, they would eliminate the second layer of tax on saving and investment. This would translate into lower government revenues and greater personal wealth in the long run.
Fundamentally Reform the Tax Code
Tax cuts are just one step towards the ideal of scrapping today's colossal federal tax code. Either a flat tax or a single-rate national sales tax would treat taxpayers more fairly, dramatically lower compliance costs, and spur economic growth. Imagine how much simpler April 15 would be after the enactment of a flat tax. The current tax code is 17,000 pages long and includes more than 1,100 forms and publications. Even IRS employees don't understand the laws that they're charged to enforce. A flat tax would save time, money, and trouble. Income tax forms would be the size of a postcard. And, because there would be no loopholes, marginal tax rates could be lowered without affecting revenues.
One of the worst problems with the current system is the alternative minimum tax (AMT). Ever year, an ever-larger number of taxpayers must recalculate their tax burden using the AMT and pay whichever is the more expensive. The AMT is unfair and should be repealed as part of the reinvention of the federal tax code.
As we grudgingly pay the taxman, we should also count our blessings. The tax burden on the American people is easing, and this has helped fuel the economic recovery. Nevertheless, all of this advancement will be lost if Congress raises taxes by letting the 2001 and 2003 tax cuts expire. But if Congress sustains this tax relief and proceeds to pass more fundamental, pro-growth reforms, April 15th may one day be much less painful.
Alison Acosta Fraser is Director of the Thomas A. Roe Institute for Economic Policy Studies, Bill Beach is Director of the Center for Data Analysis, Daniel Mitchell is McKenna Senior Fellow in Political Economy, and Keith Miller is Research Assistant, at The Heritage Foundation.