The problematic U.S. tax system

The primary sources of revenue for the U.S. government are individual and corporate taxes, and taxes that are dedicated to funding Social Security and Medicare. The federal government collected nearly $4.5 trillion in revenue in fiscal year 2023, but the government spent almost $6.2 trillion. Total U.S. debt is more than $35 trillion and growing. Would not someone in the government suggest that the spending should not exceed the income? That seems to be household mathematics, so how come few or nobody seems to care about the fact that the debt is growing?

The excessive and dysfunctional government spending would benefit from a review and making use of funds more efficient with better controls and accountability. Billions of dollars are wasted each year on inefficiencies. Also, would it not be a good idea to review the military-industrial complex and reduce the government’s military spending by a few hundred billion dollars a year. The U.S. would still have the world’s strongest military.

On the revenue side, there is also a problem. The tax system is not working properly. The reporting responsibility is up to individuals or corporations, which is different from more advanced tax systems in other countries, where information and data is handled centrally, and taxpayers and corporations basically received prepopulated tax information from the government instead of the other way around. In the U.S. it is up to you and as a result, less than 60% of individuals are paying any taxes at all and for corporation, it is even lower.  So almost half of individuals and corporations are literally not paying any taxes at all. This is not their fault, but the system is set up in a way that enables low or no taxation.

A proper tax system should not be too difficult to set up, but there is no political desire. After all, there are a limited number of tax categories. They are individual taxes, corporate tax, consumption taxes, property taxes and cross-border taxes. Many taxpayers consider the tax system unfair. They are critical of the fact that it enables many high-income individuals to pay the government a smaller percentage of their incomes than the percentage required from taxpayers with lower incomes. That is a very good point, as the tax system in effect is an asset-based model. The more assets you have, the more opportunities you have to make deductibles and lower your taxes.

U.S. taxpayers share the view that all corporations and individuals should pay their fair share of taxes, but many believe some corporations and the wealthy pay too little. Rules that allow higher-income individuals to enjoy lower tax rates than middle- and lower-income taxpayers include low rates on investment gains and deductions allowed to offset unrelated income. Sophisticated tax planning enables many wealthy individuals to minimize, or even entirely escape, estate and gift taxes.

The tax law generally applies a corporate income tax of 21%, however, many U.S. corporations pay far lower effective rates, or no tax at all, because of substantial business write-offs, carrybacks and carryforwards of losses, aggressive tax planning and, if audited, tenacious and lengthy negotiating.

On top of the problematic tax system, the government’s Internal Revenue Service (IRS) is not set up in the most efficient way to put it mildly. The IRS is understaffed, has antiquated technology, and has an inventory backlog of nearly six million paper tax returns. This will take time to improve and would require funding and focus on new technology and most likely efforts to reorganize.

There is a recent push from the IRS to target non-filers. The agency said it started sending out more than 125,000 notices to individuals who made more than $400,000 or more and failed to file returns between 2017 and 2021. Even without a tax return, the IRS has a pretty good idea about their income from forms like W2s and 1099s. Taxpayers are responsible for declaring their income, calculating their tax bills correctly and filing a return on time. The most common reasons people fail to do so are procrastination, financial woes, tax evasion or protest.

The consequences can be costly once the IRS catches up with you. There are penalties and interest for failing to file and make payments. Non-filers can also face criminal prosecution in extreme cases. One thing non-filers have not had to fear, until recently, was hearing about their shortcomings from the IRS. This seems odd, but the IRS simply has not had the staff to handle correspondence. The first batch of more than 25,000 letters will go out to taxpayers with more than $1 million in income, followed by more than 100,000 letters with incomes between $400,000 and $1 million. The notice says to file the return immediately or to explain either why you are late or don’t have to file. To make a proper investigation, the IRS would have to go lower, say to $150,000, or even lower.

The IRS will focus on high-income taxpayers as part of efforts to demonstrate to the public and Congress how it is using the tens of billions of dollars in new funding the agency received in 2022 from the Biden administration. The IRS program to pursue non-filers has only run sporadically since 2016 because of budget cuts and the pandemic that required the agency to focus on backlogs. The sad thing is that this IRS effort just shows how broken the system is.  

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