Tax Code Overhaul As Tough As Doing Your 1040 There's broad agreement among economists that a new tax system should have few loopholes and relatively low tax rates. But that's where the consensus ends. Rewriting the tax code in Washington is tricky, and as one tax expert put it, right now there is no politically feasible fix.

Tax Code Overhaul As Tough As Doing Your 1040

Tax Code Overhaul As Tough As Doing Your 1040

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Economists agree that the effort to recalculate the tax system should be guided by the principles of efficiency and simplicity. hide caption

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Economists agree that the effort to recalculate the tax system should be guided by the principles of efficiency and simplicity.

Part of a series on tax policy

Anyone who has ever filled out a 1040 form knows the U.S. tax system is complicated. The IRS says the average taxpayer devotes more than 21 hours to the annual task. While lawmakers consider whether to extend some or all of the Bush-era tax cuts this fall, some economists are calling for a more thorough overhaul of the tax code.

It’s been almost a quarter century since the tax code’s last big rewrite. Back in 1986, Republican Ronald Reagan was in the White House, Democrats ruled the House and Republicans controlled the Senate.

"If you're going to do a deal on a bipartisan basis, you have to have something in the deal that Democrats want. In ’86 that was getting rid of loopholes,” says former Sen. Bill Bradley (D-NJ). “And you have to have something that Republicans want, which in '86 was lowering the top tax rate.”

Even now, many economists on the left and the right say that's the best way to design a tax system -- with few loopholes and relatively low tax rates. But the streamlined code Bradley and his colleagues cooked up didn't last. Since 1986, more than 15,000 changes have been made to the tax code. And the instruction book for the 1040 form has more than tripled in length. When President Obama asked a panel of experts to look for ways to simplify the tax system, one member likened the current code to an untended garden.

"The problem is, the garden is growing nice flowers,” said another panelist, University of California, Berkeley professor Laura Tyson. “So it's not a matter of weeds. These things were planted."

Lawmakers are constantly adding new wrinkles to the tax code that have nothing to do with raising revenue but are all about achieving some other objective, such as encouraging home ownership or saving for college. It's easier for lawmakers to win approval of a program if it’s couched as a tax incentive rather than direct government spending, even though the effect on government coffers is identical.

"Take the mortgage interest deduction,” says William Gale of the Tax Policy Center. “You could structure that as a government spending program. And by the way, it would look ridiculously stupid if you did. Because we'd be giving huge government spending to the highest-income households with the biggest houses that are leveraged to the max. And if you look at that as a spending option, you'd say why would we ever do that?"

Stripping away these tax incentives would not be easy, since people who claim the deductions and credits tend to get pretty attached to them. But economists generally agree that eliminating these carve-outs would make taxes simpler and allow the government to raise more money without having to raise tax rates.

That's where the consensus ends. Glenn Hubbard, a former economic adviser to President George W. Bush, argued in his book Seeds of Destruction that besides broadening the income tax base, the government should eliminate taxes on dividends and capital gains to encourage savings and investment.

"You can raise the same amount of money. You can do it in at least as fair a way as we're presently doing. And you can do it in a way that actually encourages economic growth,” Hubbard says.

Lawmakers might also consider supplementing the income tax with a consumption tax or an energy tax. Bradley argued that by coupling higher gasoline taxes with higher fuel economy, the government could raise a lot of money without necessarily making driving more expensive.

"Let's say you have a dollar gasoline tax. You phase it in over 10 years,” Bradley says. “You could have a situation in five years where people would have more fuel-efficient cars, and they wouldn't be spending more money than they’re now spending on gasoline, even though the gasoline price had gone up."

None of these proposals would please everyone. Taxes rarely do. But over the long run, the government is unlikely to raise the revenue it needs to bring the deficit under control simply by raising income taxes on the very rich, as President Obama has proposed. The president seemed to acknowledge as much when he instructed a commission looking for ways to address the deficit not to take any options off the table.

"There is no solution out there right now that anyone would call politically feasible,” says Gale of the Tax Policy Center. “That's not a criticism of the solutions. That's a criticism of the mind-set of the public and the politicians. Because eventually, we are going to have to do some painful things. There is no other way out of this."

A wise tax policy could make those changes less painful and as a side benefit potentially ease the process of filling out one's tax return.