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Tax Fairness

Mary-Jo Kranacher, MBA, CPA/CFF, CFE

In an election year, more than any other time, candidates for political office play on the electorate's sense of fairness to persuade voters of policy changes they advocate. But everyone seems to have a different definition of “fair” when it comes to tax reform. Although the purpose of federal taxes is to fund our nation's budget, such as providing for national security, social services, and essential infrastructure, differences of opinion arise in deciding what functions or initiatives the government should fund, and how to fund them equitably. Should everyone pay a fixed dollar amount? A flat percentage of income? A progressively higher percentage of income depending on total income? Should the tax structure provide for deductions from income? What deductions should be allowed? Should certain types or sources of income be given preferential tax treatment? Tax fairness is shaping up to be a major issue in the 2012 elections and has captured the interest of CPA Journal readers.

Conversation Catalysts

Mitt Romney's disclosure of his 13.9% federal tax rate generated a lot of discussion over the perceived inequities of a tax system under which investment income is taxed at a lower rate than work income. A New York Times article, “Working All Day for the I.R.S.” (www.nytimes.com/2012/02/18/business/working-all-day-for-the-irs-common-sense.html ), concluded that “the disparity between the [lower] tax rates for the ultra-wealthy and those who make much less” is due to the “differing [tax] treatment of earned and unearned income.” A look at the data regarding the typical sources of income for the top 400 taxpayers explains this disparity: only 8.8% of their adjusted gross income (AGI) was from salaries or wages, 16% was from interest and dividend income, and 57% was from net capital gains. So for the wealthiest among us, unearned income represented 73%, on average, of their AGI.

Opponents of doing away with preferential rates for capital gains and dividend income argue that this would take away an important incentive to provide investment capital, which stimulates economic growth and employment. But do higher tax rates on salaries and wages discourage taxpayers from working?

Billionaire investor Warren Buffett commented in a New York Times op-ed piece— “Stop Coddling the Super Rich” (www.nytimes.com/2011/08/15/opinion/stop-coddling-the-super-rich.html)—that the tax rate he paid last year was higher than that paid by his staff. He advocated raising taxes on the rich and argued that the rich should not pay a smaller proportion of their earnings than many members of the middle class; this proposal has been referred to as the “Buffett Rule.”

We shouldn't have a different set of rules for different people.

In his opinion piece, Buffett stated, “I have worked with investors for 60 years and I have yet to see anyone?not even when capital gains rates were 39.9 percent in 1976–77—shy away from a sensible investment because of the tax rate on the potential gain. … And to those who argue that higher rates hurt job creation, I would note that a net of nearly 40 million jobs were added between 1980 and 2000. You know what's happened since then: lower tax rates and far lower job creation.”

Shared Sacrifice

To ensure long-term fiscal sustainability, spending cuts need to be made—especially to our nation's entitlement programs. our society's future promises should reflect economic reality.

Close corporate loopholes so that businesses pay their fair share. Although the U.S. corporate tax rate is 35%, few corporations actually pay this stated rate because they are able to avail themselves of some complex tax breaks.

As for income tax reform for individuals: we shouldn't have a different set of rules for different people. Here are some suggestions that could be applied to all:

  • A set amount of income should be excluded from taxes to enable taxpayers to cover a minimum level of living expenses. This amount could be adjusted based on the cost of living in specific regions and indexed for inflation annually.

  • Other deductions and exclusions should be kept to a minimum.

  • A progressive rate structure should be applied to the taxable balance, regardless of source or type of income.

  • If we must keep the alternative minimum tax (AMT), it should be indexed for inflation so it will work the way it was originally intended—to prevent the wealthy from taking excessive deductions or exclusions to avoid paying their fair share of taxes.

Taxpayers are losing confidence in the ability of our elected leaders to effectively manage our nation's fiscal woes. The perception of inequity in our tax system has compounded the problem. It is essential to bring fairness back to the tax code— our country's future may depend on it.

As always, I welcome your comments.

Mary-Jo Kranacher, MBA, CPA/CFF, CFE. Editor-in-Chief, ACFE Endowed Professor of Fraud Examination. York College, The City University of New York (CUNY) mkranacher@nysscpa.org.

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