Restructuring the tax system.

• Author: Peterson, Shirley D.

I am pleased to be with you today to discuss a subject that is near and dear to my heart: restructuring the tax system. My views on the need for restructuring grow out of a somewhat unique set of experiences. I have practiced tax law for 20 years, and I have served as both Commissioner of Internal Revenue and Assistant Attorney General in charge of the Tax Division in the U.S. Department of Justice. I have thus participated in the tax system on the inside and the outside. My work on the outside has included planning transactions and handling tax controversies and litigation. On the inside, I served as the nation's chief tax "enforcer" and then its chief tax "administrator." In short, I have just about "seen it all" when it comes to the workings of the tax system. This experience has led me to the conclusion that we should repeal the Internal Revenue Code and start over.

Some of you may have seen a recent article in Fortune magazine entitled "Our Screwed-Up Tax Code." The article began with the following statement:

The U.S. tax system is an unwieldy, inefficient, ungodly mess--and this summer's shenanigans in Washington have just made it worse. It penalizes the very investment we need to create jobs and improve living standards. It makes U.S. companies less competitive internationally and encourages them to expand overseas instead of at home.

That statement capsulizes the problem. What can we do about it? My view is that we cannot "fix" it with more tinkering at the margin. I believe that the only solution is to repeal the Internal Revenue Code and start over.

The call for reform is not new. In the mid-1970s, Secretary of the Treasury William Simon called for fundamental reform. He said: "It is time to start over from scratch and develop a new tax system in the United States. It must be a system that is designed on purpose, based on a clear and consistent set of principles, which everyone in the United States can understand." Secretary Simon commissioned a major study of the tax system, which resulted in a report entitled Blueprints for Basic Tax Reform. Blueprints stands today as perhaps the seminal work on tax reform.

Almost 20 years after Blueprints was published, Secretary Nicholas Brady issued a similar call for fundamental reform. In December 1992, the Department of Treasury issued "Restructuring the U.S. Tax System for the 21st Century: An Option for Fundamental Reform." And, now, several Democratic and Republican Senators and Congressman are working together in a bi-partisan effort to reform the tax system. Before turning to a discussion of alternative systems, I want to give you some historical perspective on the subject.

Historical Perspective

The Sixteenth Amendment to the Constitution was ratified on February 25, 1913, and the federal income tax became effective on March 1, 1913. Thus, 80 years have passed since the income tax was first enacted. As originally enacted, the income tax applied to a relatively small portion of the population and the normal rate was one percent. The maximum rate was seven percent on income over $500,000.

Beginning in the 1940s, the number of individuals subject to tax increased dramatically. In 1941, only 45 percent of the population was subject to the income tax. By 1944, that number had increased to 80 percent, and wage withholding had been implemented.

In the 50 years since World War II, the income tax has become a "mass" tax, and the Code has been riddled with deductions, exemptions, exclusions, and credits. The system is no longer, strictly speaking, an "income" tax. The current system contains elements of both a consumption base and a comprehensive income base. One problem with the current system is that we have been unable to define "income" in a consistent manner. Moreover, the current system does not tax all income alike and that failure raises concerns about equity, efficiency, and simplicity.

During the first half of this century, Congress made periodic changes to the law, but, by and large, the Code "hung together" in a way that was logical and reasonably comprehensible. Today, changes in the tax law are driven by political considerations and revenue constraints. Wise tax policy has virtually nothing to do with it. The result is a Code that does not reflect a consistent philosophy and that is so complex that the vast majority of taxpayers find it incomprehensible.

There have been many attempts at tax reform over the past 25 years, but none of those efforts has attempted to restructure the entire Code. Rather, the so-called reforms have only added to the jumble of complexity. The Tax Reform Act of 1969 was popularly referred to as the "Lawyers and Accountants Relief Act," and that Act was followed by a series of reforms in the '70s and '80s that only added layers of additional complexity to the Code.

In my view, we have reached the point where further "patchwork" will only compound the problem. The time has come to assess the continued viability of the current system and to consider a complete restructuring of the Internal Revenue Code. I want to emphasize that my call for repeal of the Internal Revenue Code is not a flippant remark. And I am not alone in my belief that we have nearly reached the end of the road.

Dean Erwin Griswold, the former Solicitor General and Dean of the Harvard Law School, made the following statement during a recent lecture to the American College of Tax Counsel. Dean Griswold said:

...[O]ur present tax system, which worked very well during the first third of this century, and struggled along during the second third of the century, has now come to the place where it is simply monstrous. We would never accept it if it had not just crept up on us, if the tax lawyers had not done their ingeniously intricate job. Something has to be done about it. It will be very hard to do.

Why Change?

There are at least four reasons for change:

* to reduce complexity,

* to reduce burden on taxpayers,

* to eliminate disincentives for savings, and

* to enhance our competitive position in a global economy.

Reduce Complexity and Burden

The current level of complexity undermines compliance. Many people believe that "others" (such as the "rich" and foreign corporations) do not pay their "fair share of tax." They attribute this perceived inequity to the complexity of the system that permits "loopholes" for those who can...