How to incorporate tax reform into tax courses.

• Author: Nellen, Annette

Editor's note: Professor Nellen is a former member of the AICPA Tax Division Task Force that produced the tax policy concept statement cited in the exhibit on p. 303 of this column, and the Tax Executive Committee. For more information about this column, contact Prof. Nellen at anellen@sjsu.edu.

About once every decade, fundamental tax reform returns to the national political agenda. Discussions about replacing the Federal income tax with a sales tax, a value-added tax (VAT) or a flat tax often become front-page news. Unfortunately, the vastness of introductory tax courses and the intricacies of tax reform preclude coverage of reform in most tax textbooks. But, in overlooking it, tax educators miss an opportunity to help students understand and appreciate tax policies and get involved in a national debate of wide interest.

This column offers an approach for including tax reform in an introductory tax course--whether at the undergraduate or graduate level. It provides a structure, basic content and student assignments. This course module will enable students to:

1. Identify key reasons why fundamental tax reform has been suggested.

2. Define "fundamental" tax reform.

3. Explain the difference between an income tax and a consumption tax.

4. Explain the basics of the flat tax, national sales tax and VAT.

5. Evaluate tax reform proposals.

   Why Is Tax Reform on the National Political Agenda?

   Typical reasons for revamping or replacing the Federal income tax include simplification and economic growth. Specific concerns often cited are that the income tax discourages savings, taxes corporate income twice, provides a preference for corporate debt over equity (because interest is deductible, but dividends are not), taxes inflationary gains, includes too many tax preferences that distort decisionmaking and creates a significant tax gap (i.e., the difference between taxes owed and taxes voluntarily paid). Also suggested is that the income tax is not sufficiently transparent, because of numerous deductions, credits and exemptions, as well as the effect of the alternative minimum tax, making it difficult for taxpayers to know their marginal tax rate.

   Student assignments:

1. Find three government reports that provide evidence supporting the claim that today's income tax is too complex. Consider looking for reports by the Joint Committee on Taxation (JCT) and the IRS's National Taxpayer Advocate. Be sure to cite your sources.

2. Give three specific examples of how to simplify today's income tax, without repealing it. Explain how each example would lead to simplification.

3. Find data from a report no more than two years old on the size of the Federal tax gap. Explain two remedies to reduce the gap, noting, for each, two challenges of implementing that solution.

4. Acting as a member of Congress, write a letter to your constituents explaining either why you do (i) not support tax reform or (ii) support tax reform.

   What Is "Fundamental" Tax Reform?

   A point often overlooked in fundamental tax reform discussions is that most proposals call for replacing the income tax with a consumption tax. Some of the proposals, such as the flat tax proposal introduced by former Congressman Dick Armey (R-TX), look like an income tax, but are really a consumption tax. Students need to know the basic differences between income and consumption taxes and how to determine the system on which a proposal is based.

   An income tax is based on revenue less cost of goods sold and allowable deductions. The formula is similar to financial accounting. Common questions that arise in creating an income tax include: What is income? Should a broad economic concept be used that would include items such as government-provided benefits, imputed rental value of owner-occupied housing and gifts received? Which expenses should be allowed to reduce income? Should rates be progressive or flat?

   A consumption tax is one on spending rather...