Simpler Taxes

The President's Economic Recovery Advisory Board, chaired by Paul Volcker, has published a report on simplifying the tax system. It's a pity the board was not asked to come up with recommendations for a comprehensive makeover. Confining themselves to their more limited mandate, they set out  a range of simplifying options, which is useful but not as useful as a reform blueprint. Anybody who fills in a US tax return each April understands something of the problem of needless complexity but for the benefit of others, below is the board's view of some provisions related to families with children. It's a lot to read -- but that's the point, isn't it.

If I were a progressive keen to reduce American resistance to expanded government, by the way, I would have two initial priorities: tax simplification, and a Race to the Top scheme to reward states that renew drivers' licenses in the 10 minutes it should take rather than the three hours it takes in places like Washington DC (whose DMV arranges things so you have to stand in line to stand in line to get a number to stand in line: that's three lines to reach the official who tells you there's a problem). Isn't it obvious that encounters with these sadistic systems are worth tens of millions of votes a year for small-government candidates?

Where was I?

The tax code provides numerous credits and deductions that reduce taxes for families with children and for child-related expenses like day care and education costs. There is also a special rate structure for unmarried individuals with family responsibilities. Currently, more than 50 million taxpayers with children claim at least one of these child-related tax benefits; most families with children receive at least two and frequently three or more.

Each of these child-related provisions has different eligibility rules, many of which are difficult to interpret or enforce and some of which we heard criticized as unfair and arbitrary. Confusion about the rules for these benefits contributes to mistakes and noncompliance.  In addition, having many different benefits often requires parents to make multiple calculations to compute each credit amount, either because the credits are determined on a specific definition of earnings or an alternative measure of income, or because a benefit phases out in certain income ranges.  Some provisions can be calculated in alternative ways, requiring parents to try different calculations to pick the most advantageous one.  The system also requires children (or their parents) to file millions of returns that raise little revenue.

To get an idea of why this is a problem, take the example of a middle-class family with teenage children aged 16 and 19, the eldest a student who lives away at college and is supported by the parents. The family has typical middle-class income, a very basic family structure, and only wage income. Under current law, the family is eligible to claim dependent exemptions for both children, allowing the parents a deduction against their taxable income.  Because they have one child under 17 they are also eligible for the $1,000 child tax credit.  The college student is too old for the child credit, but the parents may be able to claim one of a number of education credits for the student depending on the amount of their educational expenditures.

Despite the simplicity of this situation, the process for claiming the benefits for which this family may be eligible is non-trivial.  The instructions for claiming the dependent exemption include a multi-part checklist and more than two pages of instructions.  A dependent child must normally be 18 or younger and reside with the parents, but an exception applies for a student living away at school.  (However, just because the older child is a college student for the purposes of the dependent exemption does not necessarily make him eligible for education credits, which are governed by other eligibility and recordkeeping requirements.) Before calculating the child tax credit for the younger child, the parents must read through an eligibility test intended to screen out taxpayers in certain rare situations.  Like the vast majority of families, these situations do not apply to the family in this simple example, so they can skip to the next (and for them final) step: a 10-line, two-page worksheet needed to calculate the size of the child tax credit.  In this they are fortunate-a family with less income or more children may need to calculate an alternative definition of income and file an additional two-page, 13-line form for the additional child tax credit, and a family with higher income may have to calculate a reduced benefit.

Because the parents in this example pay tuition for the college student, the family would likely qualify for at least three different education benefits but must choose only one.  Making this choice will require the parents to consult an additional publication, make three separate calculations to find the most advantageous benefit, and then file additional forms to claim the credit.

Because both children are claimed as dependents by their parents, they may be subject to the "kiddie tax," requiring the college student to file a separate dependent return even if the student earns as little as $950.  If the children have high enough incomes, they may be taxed at the parents' tax rate, requiring parents and children to coordinate their filings.

As complicated as these steps are, this family has it relatively easy. At higher income levels, the child tax credit, dependent exemption, and education credits all phase out (in different income ranges), requiring additional calculations for each credit or deduction, and raising effective tax rates on family income.  At lower income levels, the situation is arguably more complex. Parents must make calculations based on different definitions of income to claim benefits like the EITC (a refundable work credit whose value is tied to the number of children) or the additional child tax credit-calculations that can require more than 100 lines on worksheets in some cases.  It is little wonder that the vast majority of the poorest families must pay a tax preparer to claim these benefits. On top of this, many family-related tax provisions are predicated on family relationships, the residence of the child, and expenditures made by taxpayers to support the child and maintain the child's household.  These rules are difficult to understand and follow, particularly for families in complicated living situations-households that include extended family and multiple generations, or that are headed by an unmarried, separated, or divorced parent. [My emphases.]

That's what you call non-trivial.

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