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There is a serious debate in my country about fiscal code reformation which involves many changes to taxation of employees. Currently, being an employee is very simple from taxation perspective: the employer computes and holds all its and employee's taxes and pays them regularly. The employer can use a fraction of its income to sponsor any organization and that's almost everything from the employee's perspective.

The newest project wants to force the employee to pay the taxes and use some deductions. Many analysts are very reluctant to this changes from various reasons: high financial illiteracy, high fiscal indiscipline, the State is already inefficient in collecting the taxes (mainly due to corruption and incompetence etc.).

However, the officials insist that a similar tax code is used in US, that it works there and we should adopt it to be more "efficient".

According to this article, US tax code is not regarded as "good":

The US tax code is falling behind its international peers and now has the third worst tax code in the developed world according a new report from the nonpartisan think tank Tax Foundation.

Tax Foundation's report, which was released Monday morning, found 31 0f the 34 developed countries in the Organisation for Economic Co-operation and Development have a better tax code than the US. Only France and Portugal ranked lower, the report said.

This Quora answer explains the technical details of the US tax law, but I am interested in the political side of the issue.

Question: Why does US have such a convoluted tax code?

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    Short answer: A combination of lobbying (to get out of paying taxes on one end; and to get government to give money on the other); and progressive social meddling (using taxes as wealth redistribution, social change agent, and way to fund their desired programs).
    – user4012
    Jun 3, 2017 at 16:17
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    I raise a huge warning here. And even more after reading @Brythan answer, but whatever "think tank" that says that the US code is one of the worst instead of Italy's one, is absolutely not trustable. I'm not biased here, I'm an Italian freelancer since 10 years, and I can swear that not even the Italian "IRS" offices know exactly how I should pay taxes and accountants have to do guesswork, to the point that two different accountants produce totally different yet correct yearly declarations.
    – motoDrizzt
    Jun 3, 2017 at 20:35
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    @PoloHoleSet: I was thinking more of tax accountants who deal with the IRS, who'd otherwise be out of work. But a quick search gives the salary range for IRS accountants as $43,449 - $91,663, which (depending on your perspective) might well be considered lucrative. Beats the heck out of what you could make picking grapes or cleaning hotel rooms, for instance :-)
    – jamesqf
    Jun 3, 2017 at 21:28
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    @blip: Sure it does. Say you as a congresscritter think that home ownership is good for the country, so you want to encourage this by making mortgage interest deductable. You get a sufficient number of your fellow critters to agree with you, and the tax code becomes more complex. Or you think people with higher incomes take advantage of too many deductions, and all the rules about Alternative Minimum Tax get added. Or you enact a health care program, and that adds more forms...
    – jamesqf
    Jun 4, 2017 at 5:33
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    @jamesqf is any of that unique to the US, though?
    – user1530
    Jun 4, 2017 at 18:50

3 Answers 3

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There's a simple way to understand the tax code: the government sets the tax rate high and then shapes behavior by giving out tax breaks for things they want to see.

For instance, many major companies pay no corporate taxes at all

Although the top corporate rate is 35 percent, hardly any company actually pays that. The report, by the Institute on Taxation and Economic Policy, a left-leaning research group in Washington, found that 100 of them — nearly 40 percent — paid no taxes in at least one year between 2008 and 2015. Eighteen, including General Electric, International Paper, Priceline.com and PG&E, incurred a total federal income tax bill of less than zero over the entire eight-year period — meaning they received rebates. The institute used the companies’ own regulatory filings to compute their tax rates.

As in

Facebook, Aetna and Exxon Mobil, among others, saved billions in taxes by giving options to top executives to buy stock in the future at a discount. The companies then get to deduct their huge payouts as a loss. Facebook used excess tax benefits from stock options to reduce its federal and state taxes by $5.78 billion from 2010 to 2015, the institute found.

Sometimes the breaks aren't breaks, but oversights (see overseas profits, etc), but quite often, someone somewhere wanted to see certain behavior. Personally, I get a deduction for paying interest to my bank in the form of a home mortgage. I can set aside money in an Individual Retirement Account(IRA) or a 401k. My health insurance premiums are pre-tax. After deductions, I often pay no income tax. But making sure I do that... costs money. I pay a CPA to do my taxes for that reason (trying to comply with all those rules is a pain). Companies can do that on a large scale.

Why do it this way?

  1. People like the deduction system despite the convolution.
  2. Most taxes are obfuscated. Ask the average American how much they paid in actual taxes, or what rate they paid. They probably couldn't tell you.
  3. Corporate taxes aren't generally well known. So while it might be outrageous that some don't pay any taxes, it's proven difficult to raise enough awareness to get political movement (hence articles like the one I linked)
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  • FWIW, the March 2017 report of the CBO on international Comparisons of Corporate Income tax Rates, the US is third among the G20 nations for average Corporate tax rate (Argentina and Indonesia being almost 8 % higher. Comparison of Effective corporate tax rates, the US lags behind Argentina, Japan and UK. see cbo.gov/system/files/115th-congress-2017-2018/reports/…
    – BobE
    Aug 18, 2017 at 18:38
  • Point 2 seems bizarre that people can't tell you what rate or how much tax they paid despite individually filing? I expect that Inthe UK where PAYE means you never think about tax, but the commonly told story of the US system where everyone has to actively involve themselves in tax, to hear that still don't know what they paid is staggering.
    – Jontia
    May 7, 2023 at 6:28
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    @Jontia: You can just look at your "total tax" amount (Form 1040 line 24) to see your federal income tax bill for the year. But since most people are making payments throughout the year (either auto-withheld from paychecks and reported on Form W-2, or self-employed people and investors paying estimated tax), people tend to gloss over that number and focus on their refund (line 34) or amount owed (line 37), depending on the sign of the difference between tax and payments.
    – dan04
    May 7, 2023 at 6:40
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Tax Foundation

Well, let's look at what the report actually says,

"The United States scores poorly largely because it maintains the highest corporate tax rate in the developed world at 39.1 percent and is one of the six remaining countries in the OECD with a worldwide system of taxation," the Tax Foundation said. "Its poorly structured property, individual, and capital gains and dividends taxes also contribute to the low ranking."

and

"No longer can a country tax business investment and activity at a high rate without adversely affecting its economic performance," a co-author of the report, Kyle Pomerleau, said in a statement. "In recent years, many countries have recognized this fact and have moved to reform their tax codes to be more competitive. However, others have failed to do so and are falling behind the global movement."

So what that report is complaining about is primarily a high nominal rate (39%) on corporate income that is charged globally. The effective rate is lower, around 27%. To get that lower effective rate, they implement a lot of deductions. So roughly a third of income is exempt from taxation for one reason or another.

They also charge corporations tax on all income earned globally. Because other countries mostly charge tax just on income earned in their own territory. This produces a situation where companies are incented to locate their headquarters outside the US but do business in the US. Because that combination avoids the global and territorial taxes. And companies are incented against locating their headquarters in the US and doing business outside the US, because then they pay both global and territorial taxes. Companies that have to do that often leave their profits in their overseas subsidiaries so as to avoid the global tax on returning income.

Property taxes are local (county, school district, and municipality) taxes. The Tax Foundation doesn't like them because rich people pay a lot.

The point being that those issues have nothing to do with choosing who pays individual income tax. They are complaining a lot about how business taxes are structured rather than personal taxes.

Quora

The Quora post is focusing on something different. Because of the way that the US tax code developed, they repeatedly found ways that the tax code was unfair and charged people who had no excess income to pay the taxes. So they added exceptions. Then people that did have money to pay the taxes would find new ways to use the exceptions. So the government would make a new rule to catch those people.

Take the deduction on state and local taxes for example. Typical working class people can't take this. Even if they have enough income to pay income taxes, they don't pay enough state and local taxes to be worth replacing the standard deduction with itemized deductions. Most middle class people who take this deduction combine it with the deduction for mortgage interest.

The simple fix for all this would be to get rid of the deductions on mortgage interest and state and local taxes and increase the standard deduction. But of course that is unpopular with people who took the deductions in the past, who currently take the deductions, or who think they might take the deductions in the future. That is so even if they would actually be better off with the higher standard deduction.

What they actually did was to create something called the Alternative Minimum Tax (AMT). The AMT says that even after taking deductions, higher income people must still pay a certain amount of tax on employment income. But the AMT rate is still below the top marginal rate. So there is a lot of incentive to pay just the AMT rate, making a mockery of the top rate. And the AMT rate doesn't apply to capital income (capital gains, dividends, etc.).

There is also a problem in that there is a business in preparing taxes. While full time participants may only be about 40,000, over a million people do paid tax preparation during tax season. Those people and various software companies with tax preparation software have an incentive to keep taxes complicated. So they lobby against any changes to simplify the tax code. Not only do they lobby politicians, but they also demonize changes with the general public. For example, they oppose eliminating the mortgage interest deduction.

The problem is that the mortgage interest deduction sounds great on its face. Encourages home ownership! Gives a break to families struggling to afford their house! But in practice, the actual savings for those kinds of families are small. The people who really benefit are those at the upper end of the deduction. And the truth is that someone who can get a $500,000 mortgage is not that poor. So a bad policy continues because it sounds much better than it actually is.

This is less of an issue with business taxes, as businesses expect to pay accountants regardless. There isn't the same pressure to keep the taxes complicated to keep business accountants employed.

That is a downside of charging taxes to individuals. The paid tax preparer lobby then has an incentive to keep taxes complicated.

Upside

There is an upside though. If the businesses are making tax payments for employees who actually owe the tax, then that gives two groups who are responsible for reporting income and auditors can catch either of them not reporting. It's the same principle as Value-Added Tax (VAT). Because the seller remits the tax but it is the buyer who pays it, the seller has less incentive to avoid paying the tax. And the buyer actively wants proof of paying the tax, as they can deduct taxes paid against their own tax payments.

In theory, charging the tax just once would be simpler. In practice though, people still have to file the paperwork anyway. Because they have to explain why they did not charge the tax. Paying the tax at each step is about the same work and makes it so that there is one party that wants to report it.

Moving to an income tax system where individuals are responsible, but businesses actually handle most of the payments works the same way. The employees want credit for the taxes being paid. If the employers just pocket the taxes, then they can't deduct the employee's wages or salary from the business income taxes. And they risk getting caught if someone notices that the employee has money but no income.

If I were creating a system from scratch, I'm not sure that's how I'd do it. Rather than making employers remit the tax, I'd have banks do it. Because the truth is that they are in a better position to see all the income than employers. But there are reasons to support an income tax (owed by individuals) over a payroll tax (paid by businesses).

Another reason is that individuals pay taxes on things other than their employment compensation. Capital gains, dividends, interest, business income, etc. It's not clear to me how those get charged in your system, so I won't comment on specifics. (That's not a question--this is already at the broad end of the question spectrum. It would probably be better to ask about that kind of stuff in a separate question if you're still curious.)

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  • Thanks for the exhaustive answer. Although there are the aforementioned upsides, just the fact that you have to pay someone (except in cases you really know how the system works) in order to efficiently pay your taxes does not sound good. Some bureaucracy associated with taxation is clearly needed, but I thought the purpose of any decent state is to minimize it. An interesting fact is that ease of doing business index for US is a very good one, so the complex fiscal code is outweighed by other economical advantages.
    – Alexei
    Jun 3, 2017 at 19:58
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The US tax system was built from the ground up as a series of exceptions.

"Tax Revolt" is a fundamental part of the American Foundation Story. "Unfair taxes" conflict with the basic political idea of America.

The system started with the idea that tax is wrong, and only justified for manifestly unjust richness (an exception to the idea that tax is wrong). It's evolved as a series of exceptions to try and bolt "fairness" onto an "intrinsically wrong idea".

The complication comes from the fact that, just as "tax the rich" was an exception to the idea "tax is wrong", each exception (to try to achieve fairness) in the American tax system is modified by a further exception (restore balance of fairness), perhaps modified by another exception (restore balance of balance of fairness), and perhaps another exception (restore balance of balance of balance of fairness)

This is different to countries which start with the political ideal "everybody should pay tax", and are always striving to achieve political correctness by removing exemptions.

Of course, in all countries, special interest groups are striving to create tax exemptions, and the USA is notable for the success of special-interest lobby groups in all areas of politics, so that plays into it. But part of their success in America is due to the fact that America doesn't see anything fundamentally wrong with the idea of a tax system built as an edifice of exceptions.

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    To the extent that the Revolution was about taxation, it was about "taxation without representation". Every colony had taxes and tariffs that it used to sustain itself and this was uncontroversial. What the colonists objected to was Parliament making capricious and arbitrary changes to taxes (and in some cases, like the tariff reduction that led to the Boston Tea Party, changes that favored Parliament's friends in the East India Company over local commercial interests). They never doubted that a proper representative government, with the backing of its people, could levy tax.
    – Cadence
    May 7, 2023 at 9:24
  • The claims being made here need some citations. The Constitution gives the federal government the express, sole power to issue tariffs. States had the power to tax citizens in their Constitutions, for example the Virginia Constitution Art 4 Sec 14 grants the General Assembly the power to legislate anything not forbidden, and later forbids taxes that would apply only to a particular locality, which implies a general taxing power. There is some debate over the legitimacy of federal taxes on individuals but it's not over whether taxes are unjust per se. May 7, 2023 at 15:13

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