Taxes, Simplified for Better Government

-by Sebastian H

Part II.  Part I Can Be Found Here

One of the main reasons why the US tax code is so complicated is that it has tens of thousands of policy choices as tax deductions, tax credits, and other forms of tax breaks.  I obviously can't comment on all of them individually (though I will comment on the top 5) but I can comment on them as a whole.  For the most part, putting policy decisions in the tax code is a bad idea.  It does a number of things that are not conducive to good government.

1) It hides subsidies.  Things can get tucked away in the tax code which probably wouldn't survive as open subsidies--especially because it isn't always as obvious how much money is in the subsidy unlike budget items for direct subsidies.  

2) It allows recipients of the subsidies to feel like they aren't getting anything special from the government.  This particular problem tends to exhibit itself in the idea that many of the rich are paying without getting much in return..  As we will see, many of the largest tax-oriented subsidies end up being directed to the rich and very rich, who don't see them as subsidies.

3) It makes taxation more complicated and distorts people's decisions.

My proposal is simple.  We don't make subsidies through the tax code.  If something is important to subsidize, do so directly.  Otherwise don't.  Now admittedly this is a long term goal.  It isn't fair to cut tax subsidies that people have been relying on immediately, but we certainly could phase them out.  

So here are the top 5 tax breaks according to the Congressional Joint Committee on Taxation: (hat tip Jeanne Sahadi).

 The Mortgage Interest Deduction is a clear subsidy.  It is worth about $573 billion.  It was part of the strong government effort to get more people to own their residences.   It has also turned into a pretty clear subsidy for the rich:

Of those who had mortgages in 2008, roughly 72% claimed the mortgage deduction. But those who benefited most were higher-income households, according to the Joint Committee on Taxation.

Almost half of the returns claiming the deduction were from filers with incomes over $100,000, and roughly 75% in foregone revenue that year went to them.

Meanwhile, 32% of the money went to households with incomes over $200,000, even though they accounted for only 11% of the returns claiming the deduction.

Moreover, since housing is treated more favorably tax-wise than other investments such as stocks, some economists believe the home tax breaks distort people's investment decisions. By making the mortgage deduction less valuable, they argue, that could make the economy more efficient overall.

Now I can't prove that a mortgage interest subsidy which was sold as going 75% to people with incomes over $100,000 would not pass in Congress.  But I strongly suspect it wouldn't.  It is effectively a $430 billion subsidy to people with large mortgages and incomes over $100,000.  It probably isn't a good idea in general, and certainly not scaling all the way up to one million dollar mortgages.  I would propose that the mortgage interest deduction be removed and replaced with a similar (but to be phased out) subsidy.  And the only reason I would do that is because it wouldn't be fair to those who relied on the deduction when making purchasing decisions.  

The next large subsidy is the health care subsidy for work based plans.  It is also enormous (though if I understood the health care debate properly it is at least partially on the way out).  It strikes me as much more defensible policy than the mortgage deduction, but it makes much more sense as a direct subsidy rather than a tax treatment.  

The exclusion of retirement plan contributions doesn't strike me so much as a subsidy, as a choice about when to tax the money.  I'm open to either treatment really.

The lower tax rate on dividends/cap gains is definitely a subsidy but would be better dealt with under my forthcoming "What is Income" post, so I'll defer discussion of that item.

The EITC is a subsidy, but it is one of the few that actually works more efficiently through the tax system than outside of it.  It operates on a sliding scale based on income, and is designed to automatically reduce the subsidy as your income goes up--a method which lends itself well to being integrated directly into the tax structure.  Since federal taxation is on income, and the subsidy is directly connected to income, it isn't any more distorting to put it directly in the tax code.  My earlier proposal (linked above) has EITC properties in the ramp up to the basic tax rate.  

Comments

[russell]

First, thanks Seb for these posts.

Next, from the Sahadi piece Seb links to:

Currently, individuals owning a first or second home can deduct the interest on up to $1 million in loans used to buy, build or improve the home. They can also deduct the interest on an additional $100,000 on loans secured using the home as collateral, regardless of how the money is used.

I don't know if part of the goal here is making this less of a subsidy for the wealthy, specifically, or not. If so, it seems to me that simple first steps here would be:

1. First home only, mortgage on second homes is not deductible.
2. Scale the maximum deductible amount back from $1,000,000 to, say, a half million.
3. No deduction for loans secured against the home.

These might also be a useful first step in rolling back the deduction overall.

I don't know what that would net us in increased revenue.

[hairshirthedonist]

Wouldn't it be simpler to limit the mortgage interest that can be deducted in a given year to a dollar amount (say $25K) rather than limiting the amount of the mortgage? Or would that lead to shenanigans I'm not devious enough to think of?

[Pat]

In my concurrence, I will add that subsidies can be administered by an agency set up for that purposes and staffed with experts in (or at least dedicated bureaucrats who focus on) that one particular industry, as opposed to having the IRS administer everything under the sun.

[Slartibartfast]

Yes, thanks for these, Sebastian. Even though they're sneakily just all about benefiting the rich at the expense of the less of well-off.

And of course, Sebastian being one of the really, really rich people is going to make out like a BANDIT, if this stuff ever gets implemented.

[Jacob Davies]

"It has also turned into a pretty clear subsidy for the rich"

Not only that, it is a massive borrowing subsidy that encourages the most irresponsible behavior with debt - that is, the highest LTV ratios, the most equity withdrawal, the lowest payments - and provides a huge disincentive to actually pay off a mortgage. I think it was a major factor in the insolvency crisis that followed the housing bubble - it is far cheaper to borrow with a HELOC than a credit card and the result is the disastrous LTVs and enormous numbers of foreclosures we've seen.

It is a hugely destructive subsidy. At the very least it should come with caps on loan size and restrictions on home equity withdrawals.

The problem with the health care subsidy is that it pushes consumption spending towards health care, which encourages a medicalization of solutions to problems, and because the most expensive health plans do little cost-sharing with individual participants, means that there is little incentive to reduce costs since all your coworkers are paying for you. If you imagine a given problem that can be solved either with non-medical consumption (let's say, exercise and eating better) or medical consumption (a pill or surgery) there is no reason that the latter should get a large subsidy while the former does not.

What I would like is a baseline of care that is guaranteed and tax-advantaged in the same way regardless of whether you are employed or self-employed, and no tax subsidies above that level. Some criteria for medically-useful and cost-effective care could be used to determine what was covered, and above that level, you can still have health insurance or pay out of pocket, but it's not tax-advantaged. I think we're headed there pretty fast, which is the good news.

I think you're right about the EITC. For retirement programs, I don't have a cite, but I believe the net effect is extremely regressive regardless of intentions. If I am recalling that correctly, then more measures to reduce the regressiveness would be in order.

This post is more interesting than the last because these deductions are really the 2nd biggest problem with fairness in the tax code, not complexity. (The biggest being insufficient progressiveness in rates, which is not a problem of complexity.)

[Jacob Davies]

Er, "lower caps on loan size". Carry on.

[hairshirthedonist]

Or would that lead to shenanigans I'm not devious enough to think of?

I think I'm now looking at you, Jacob Davies, when asking this question.

[Jacob Davies]

Oh, sure, cause I look that dishonest, I know.

Actually I don't know what effect a cap on the total subsidy would have. Maybe something really perverse like a loan with varying interest rates & payments over the course of the loan that keep the nominal interest paid at the cap for as much of the loan as possible; basically, reduce the interest rate early on when the balance is high, and increase it later when the balance is low, with a net neutral effect on total loan payments, and some kind of early repayment penalty to recover the higher interest in the out years - but I assume there are existing legal limits on how much you can game the interest rate and repayment structure of a house loan. (Of course, one might have assumed that negative-amortization loans & all kinds of weird ARMs would have been banned by sensible legal limits, but they weren't.)

Not sure whether banks would be interested in cooperating to that degree, but they're pretty good about figuring out where they can get an angle.

[bobbyp]

Those tax breaks....

#1: Agree. Should be phased out like all other interest rate deductions were (remember those days when you could write off credit card interest?). This subsidy also tends to promote suburban sprawl.

#2: A single payer plan would eliminate the need for this tax break entirely.

#3: I'd go for excluding that if you eliminated tax exemptions for insurance products like annuities, life insurance, etc. Otherwise, like you say, not. Maybe we could have a fund 'matching' subsidy!

#4: This is a crime and should be eliminated immediately.

#5: One of the most effective tax tools in the interests of equity and justice out there. If we didn't have a society that insisted on having poor people, this could be eliminated.

Subsidies: We all see the actual costs of current subsidies (cf agriculture, import/export bank, defense procurement spending). Somehow, the connection between cost and income is not made by most voters. Wouldn't this fact tend to undermine your basic premise somewhat? More basically, politics is about cutting up the pie. It will always be messy.

[Tony P.]

This post is more interesting than the last because these deductions are really the 2nd biggest problem with fairness in the tax code, not complexity. (The biggest being insufficient progressiveness in rates, which is not a problem of complexity.)

Starting from the status quo, we can (to first order) raise $430B from households with income over $100K (or $183B from households with income over $200K) in two different ways.

We can eliminate the mortgage deduction; or

We can adjust the tax rates on their incomes.

Keeping in mind that we have to start from the status quo, which of those would be simpler? Which would be fairer?

If we were starting from scratch, I would be inclined to oppose the mortgage deduction. But starting from scratch is not an option we have.

--TP

[Jacob Davies]

Those are not mutually-exclusive options.

[Roger Moore]

We can eliminate the mortgage deduction; or

We can adjust the tax rates on their incomes.

Or, we can do some mix of the two. For example, we could eliminate the deduction on second homes, reduce the amount of mortgage that's covered, and/or cap the total amount that can be deducted. That would reduce but not eliminate the amount of money deducted, which would allow us to make up the rest of the money with a smaller tax increase on the group as a whole.

[Phil]

The exclusion of retirement plan contributions doesn't strike me so much as a subsidy, as a choice about when to tax the money. I'm open to either treatment really.

FWIW, my municipality does levy local income taxes on pre-tax gross income, not net, including retirement plan contributions.

[Mike Schilling]

And of course, Sebastian being one of the really, really rich people is going to make out like a BANDIT, if this stuff ever gets implemented.

Like that's news? We all know how much you fancy-pants bloggers make.

[George]

Perhaps I am naive, but I am looking for fairness in the tax code. I don't know that I see the home mortgage interest deduction as a subsidy so much as the one exception to an unreasonable position. If interest received is taxable, interest paid should not be taxed. All interest paid should be excluded from income. Likewise, if gambling winnings are taxable, gambling losses should be excluded ; the full amount, not just up to the amount won.

[Chuchundra]

As a recent home buyer, let me offer at least a qualified defense of the mortgage interest deduction, it's one of the few subsidies that flows disproportionately to the blue states. Blue states tend to have higher property values, higher costs of living and higher incomes to offset that. Those $100K+ income earners making out on the deduction? Yes, the missus and I fall into that category when you combine our incomes, but around here that makes us solidly middle middle class.

Moreover, the mortgage interest deduction is a lot more valuable in the blue states since we tend to have higher state and local taxes, which you I can now deduct since the mortgage interest pushes me over the standard deduction threshhold.

[Bob L.]

Some tax subsidies, not of the same dollar magnitude but still up there in the multi-billions, wind up spending far more in forgone revenue than they generate in added economic activity. One obvious example is a deduction or credit for businesses that hire additional workers. Sure, it induces some businesses to hire that otherwise wouldn't have. But the same subsidy is also available to those businesses that would have hired new people anyway, even without the subsidy. So you wind up rewarding more behavior than you induce, often lots more. The marginal cost far exceeds the marginal benefit, even without regard to who benefits.

More generally, a tax subsidy that is intended to induce added activity may prove less efficient than a corresponding direct expenditure. Cut the taxes on people who already have discretionary income and they're likely to save some of it and spend much of the rest on things that are not labor-intensive, like antiques. Give cash directly to low-income people (it's called unemployment compensation) and they'll spend it on necessities, which tend to be labor-intensive items like food, clothing, and transportation. That's one reason why the least stimulative part of the recent stimulus act was the tax cuts, the most stimulative being unemployment benefits and direct payments to state governments for salaries and capital projects.

This isn't rocket science. I know almost nothing about economics, but I know this much is true. Denying it is like denying evolution or global climate change - not only foolish but dangerous. Maybe we are a nation of idiots after all.

[russell]

We can adjust the tax rates on their incomes.

Tony, how much would we have to raise top marginal rates on incomes over $100K to get $430B?

And, can anyone explain why we are allowing a mortgage deduction on second homes?

[Slartibartfast]

Likewise, if gambling winnings are taxable, gambling losses should be excluded ; the full amount, not just up to the amount won.

Nope, I draw the line here. Gambling is entertainment, not investment. If you choose to spend all of your income on entertainment, you're still going to have to cough up the taxes on that income, in my book. Your bad judgement is not my problem.

[Marty]

" If you choose to spend all of your income on entertainment, you're still going to have to cough up the taxes on that income, in my book."

I agree that that you should not be able to write off gambling losses. it is also absurd to tax winnings 40%. It is entertainment, absolutely, but most people don't keep track of their $10 here and $10 there losses, but let them win $1000 and Uncle is there to get his. And this is one of the most regressive taxes ever invented.

[rea]

Gambling is entertainment, not investment. If you choose to spend all of your income on entertainment, you're still going to have to cough up the taxes on that income, in my book. Your bad judgement is not my problem.

A powerful reason not to allow a deduction for losses ont he stock market.

And this is one of the most regressive taxes ever invented.

Only to the extent that income tax is regressive, since there is no particu.lar tax on gambling winnigns--the law simply recognizes such winnings as income, which they are, as a matter of common sense.

[Marty]

"the law simply recognizes such winnings as income, which they are, as a matter of common sense."

This just misses the point, of course. Most wealthy gamblers keep great track of their winnings and losses usually being able to prove they lose more than they win. Most average or poor people who spend 3 bucks a week on lottery tickets plus a little here and there pay taxes on anything they win over 600 dollars. Most state lotteries are really a regressive tax and other forms of legal gambling favor the rich.

[Mike Schilling]

Most state lotteries are really a regressive tax

No argument here. If rich people's gambling (the stock market) is tax-advantaged, why not poor people's gambling?

[russell]

it is also absurd to tax winnings 40%.

aren't gambling winnings taxed as plain old income?

[Sebastian]

Gambling winnings definitely count as ordinary income. Is it maybe initially withheld at 40% and then you get some of that back? The withholding regime as it currently plays out is another doozy, but it probably won't be the focus of any part of my tax series as eventually you just have to pick your battles.

[Turbulence]

As a recent home buyer, let me offer at least a qualified defense of the mortgage interest deduction, it's one of the few subsidies that flows disproportionately to the blue states. Blue states tend to have higher property values, higher costs of living and higher incomes to offset that.

As a blue-stater myself, I really don't find this convincing. Blue states tend to be wealthy so in any remotely progressive system, they're going to have to pay more than red states. If changing the interest deduction really screws them, the change will only happen if they get some sort of offsetting benefit. Horse-trading is one thing our congress is skilled at.

Moreover, part of the reason that blue state housing costs more is because of scarcity in built up areas on the coasts. When you run out of land, prices have to go up. But the rate at which they go up is affected by things like the interest deduction. Limiting or eliminating the deduction might very well lower the long term rate of growth in home prices in blue states.

Finally, I'm not even sure I believe your claim that the home mortgage interest deduction disproportionately benefits blue states. It seems that the subsidy disproportionately benefits wealthier suburbs, but such places are all over the ideological map. I mean, New Jersey is a wealthy blue state on average, but the richer commuter suburbs that benefit the most from the deduction are more conservative than the state as a whole. I suspect that this type of analysis requires much finer granularity than just looking at the state level.

[hairshirthedonist]

Blue states tend to be wealthy so in any remotely progressive system, they're going to have to pay more than red states. If changing the interest deduction really screws them, the change will only happen if they get some sort of offsetting benefit.

Maybe, but that doesn't mean it doesn't now work as described in the qualified defense.

Limiting or eliminating the deduction might very well lower the long term rate of growth in home prices in blue states.

The same goes for this.

I mean, New Jersey is a wealthy blue state on average, but the richer commuter suburbs that benefit the most from the deduction are more conservative than the state as a whole.

Richer suburbanites in New Jersey are still probably more liberal than richer suburbanites in, say, Utah. I'm not sure I get why intra-state relative conservatism should matter to an already qualified defense of the subsidy. It has no bearing on the fact that the subsidy favors blue states and that it is one of relatively few that do so.

[hairshirthedonist]

I should probably add that the use of the phrase "blue states" shouldn't be taken to mean that the defense of the subsidy is based on the fact that the individuals benefiting from it the most are more liberal. It think it's just that those happen to be the states that generally benefit relatively little from subsidies in general, so political granularity is irrelevent.

[Ugh]

RE: Gambling losses. Unless you're a professional gambler, I don't see the justification for allowing someone who makes $50K a year working for Company X getting to deduct the $5k he blew at the craps tables in Vegas from his $50k salary. It would be the federal government subsidizing gamblers.

Now, if you truly are a professional gambler who also makes money on the side, then you might (might) be permitted to deduct gambling losses in excess of winnings from your income in that other income, but I'm not sure about that.

[elm]

Ugh: That's actually more or less how it works now.

You can deduct gambling losses only to offset gambling income and only if you itemize.

(Aside: The itemization requirement for the mortgage interest deduction contributes to its regressiveness. Lower-income people just don't itemize.)

If you win $5000 gambling but lost $2000, you are ultimately taxed on $3000.

On the other hand, if you won $2000 gambling and lost $5000, you cannot apply that extra $3000 loss as a deduction to your regular income, that just disappears (I don't know if you can apply it to previous or subsequent years).

[jrudkis]

(Aside: The itemization requirement for the mortgage interest deduction contributes to its regressiveness. Lower-income people just don't itemize.)

Lower income people don't itemize because the standard deduction is larger than they can itemize. When I bought my first house I was very dissapointed to learn that even with the mortgage deduction, I could not deduct more than the standard deduction. I think that means that the standard deduction is designed to counteract the regressive nature: lower income people can deduct more than the could otherwise itemize.

[Ugh]

elm: Yeah, I was just responding to the notion that gambling losses should be deductible in full regardless of gambling winnings. I mean, why not make expenditures on beer deductible?

[Turbulence]

I get why intra-state relative conservatism should matter to an already qualified defense of the subsidy. It has no bearing on the fact that the subsidy favors blue states and that it is one of relatively few that do so.

I think there are two plausible interpretations of what "favoring the blue states might mean". I assumed it meant: "benefiting a significant fraction of blue state residents" but reviewing it I see that it might instead mean "transfer cash on net to blue states". The difference lies in the expected distribution of benefits. If the government decided that no one who made more than $1million each year had to pay taxes, that change would "favor the blue states" according to the second interpretation but not the first.

As a blue state resident, I do not see much benefit to tax code changes that simply transfer cash to wealthy people. I do see benefits to tax changes that benefit a significant fraction of the population. In order to figure out whether modifying the interest deduction actually harms a non-trivial number of blue-staters, we have to consider which blue-state residents benefit now.

Do you favor arbitrary tax changes that would transfer large amounts of cash to a handful of extremely wealthy blue state individuals? Such changes would "favor the blue states", right?

[jrudkis]

"elm: Yeah, I was just responding to the notion that gambling losses should be deductible in full regardless of gambling winnings. I mean, why not make expenditures on beer deductible?"

Well, I can deduct the state taxes I pay on beer. And I can probably deduct some of the cost as entertainment expenses.

I think the point is that if you can't deduct gambling losses, you shouldn't have to pay on winnings. That simply seems fair.

[Ugh]

I think the point is that if you can't deduct gambling losses, you shouldn't have to pay on winnings. That simply seems fair.

Because gambling losses are personal expenditures, which are not generally deductible for tax purposes (unless, again, you are in the business of being a professional gambler).

However, since gambling is a somewhat unique personal activity such that you have a fair chance of making money from it (as opposed to, say, buying tickets to see a movie), the Code allows you to offset losses against your winnings, much like capital losses and gains (though under differing rationales). But you don't get to offset losses against other income unrelated to gambling.

Now, of course, you might make money from your movie ticket by, say, waiting in line to get a ticket to the first showing of the newest blockbuster, and then selling your ticket for more than you paid for it. You would, of course, owe tax on the difference between what you paid for the ticket and what you sold it for, but I don't think that creates a rationale for letting you deduct the cost of all the movie tickets you purchase in a particular year.

[jrudkis]

Because gambling losses are personal expenditures, which are not generally deductible for tax purposes (unless, again, you are in the business of being a professional gambler).

But it is an activity that people take part in to make money. Most activities that you take part in to make money are deductible. However, most people fail to make money at it.

Essentially, it seems that gambling is treated as a separate business for everyone who partakes, but without the structure required for other businesses...so you can deduct the loss of gambling from your winnings, but probably not your travel to Las Vegas, hotel room, rental car, etc., that you could if you were there for a convention. And there is no carry over.

And as pointed out above, based on the state sponsorship of gambling with lotteries and legalized casinos, it is a very regressive and cynical tax on people who are not good at math.

[hairshirthedonist]

Do you favor arbitrary tax changes that would transfer large amounts of cash to a handful of extremely wealthy blue state individuals? Such changes would "favor the blue states", right?

No and yes. Point taken.

[elm]

why not make expenditures on beer deductible?

I hope this is something that everyone can support.

Also, I'm entirely in favor of eliminating the mortgage interest deduction (which I do currently benefit from). Phase it out by eliminating the second home and HELOC deductions rapidly and then reduce the loan value limit over 10-20 years. It's a politically popular program but economists largely agree that it does little to affect home ownership and little to encourage building. It's not at all clear that there is any net benefit to that deduction.

[Ugh]

But it is an activity that people take part in to make money.

Well, I think it is an activity that people take part in in order to experience the thrill of the possibility to make money, essentially for doing nothing and having a good time in the process. No doubt, no one would gamble if you were guaranteed not to make any money on a particular wager (absent some other benefit, "Cocktails? Cocktails?").

But this is where the genius of Vegas kicks in. Sure, over the long term you're going to lose money gambling (unless you're one of these guys or, say, Phil Ivey), but who knows on any given night, plus, Vegas Baby! Vegas! In sum, as Slarti notes above, it's entertainment unless you make it your business.

And I would note that this is not unique to gambling, there are the passive activity loss limitation rules, the hobby loss rules (e.g., you like to make wood carvings in your spare time, every so often you sell one, doesn't mean you get to deduct your wood carving expenses against your income from working for Company X) and other assorted rules limiting the extent to which you can deduct expenses from a nominally income generating activity.

Which, I guess, is Congress's view: the vast majority of people who engage in gambling in the United States do not do so as part of their trade or business, thus the expenses allocable thereto (as you note, plane ticket, hotel room, etc.) are not deductible, and direct losses from the activity are deductible only to the extent of income.

I agree with the regressive and cynical tax on people who are not good at math point, at least with respect to state run lottos (since I would put the privately run, but state regulated, casinos in the entertainment category).

[Bernard Yomtov]

Good post, Sebastian.

One thing I do disagree on:

The exclusion of retirement plan contributions doesn't strike me so much as a subsidy, as a choice about when to tax the money.

It actually is a subsidy because:

Withdrawals from IRA's and the like are taken more or less at the taxpayer's discretion. Any time you can control the timing of income you can play the tax code, at least a little, maybe a lot, so as to minimize the tax. This is also an issue with capital gains taxation.

The deferral of taxes on income put into retirment accounts is quite valuable, as all those mutual fund ads are forever pointing out. If you get to compound the earnings tax-free you are way ahead. The net effect is that, on a present value basis, you are getting a substantial tax break on the income you put in the account. And the postponement also helps because people tend to have lower incomes after retirement, hence lower tax rates.

[Marty]

"The exclusion of retirement plan contributions doesn't strike me so much as a subsidy, as a choice about when to tax the money. "

This seems a very counterproductive place to try to save money. In years past, some much higher percentage of workers achieved the goal of a retirement income through vehicles called, uh, retirement plans. These were funded by most companies and were the reason that people were willing to work for one company for a lifetime rather than jump from place to place.

These retirement plans only exist now for Federal workers and union workers.

The best way to entice people to save for their retirement early on in their lifetime is to provide these kinds of incentives, tax incentives being a great one.

In the long run I think that thye whole idea of "gaming" the tax system by taking the money out when it is best for the individual is the REASON for doing it in the first place.

Doing away with a way to incent people to save, which to me seems to be a rational goal of our society, seems to be less than optimal policy.

[hairshirthedonist]

And as pointed out above, based on the state sponsorship of gambling with lotteries and legalized casinos, it is a very regressive and cynical tax on people who are not good at math.

I agree. But taxing people on net winnings discourages gambling. Not allowing deductions for net losses also discourages gambling. You feel the full pain of the loss and lose out on some of the winning. It is consistent in terms of discouraging the behavior. I say "good."

[Turbulence]

This seems a very counterproductive place to try to save money.

I'm not 100% sure that Seb is proposing saving money here per se. It seems like he's advocating for moving this subsidy out of the tax code. That could be done in a revenue neutral fashion so that you'd get no tax break for retirement contributions but the government would send you an explicit subsidy check every year. Even though it would be revenue neutral, that arrangement would at least make crystal clear the fact that they're getting a big welfare check I mean handout I mean just deserts due them for their hard work. And once that understanding sets in over a few years, it might be easier to have a rational discussion about just what those subsidies should be.

[Marty]

" You feel the full pain of the loss and lose out on some of the winning. It is consistent in terms of discouraging the behavior. I say "good.""

So everybody's pet peeve gets included in the tax code, oh yeah, that's why it is the way it is today.

[jrudkis]

I agree. But taxing people on net winnings discourages gambling. Not allowing deductions for net losses also discourages gambling. You feel the full pain of the loss and lose out on some of the winning. It is consistent in terms of discouraging the behavior. I say "good."

It discourages very little because people bad at math are also unlikely to understand the tax consequences of gambling policy. A good policy to discourage gambling is making it illegal, not having state run lotteries with the worst possible odds, and preventing advertisement of gambling like tobacco. Otherwise, you really are simply preying on people who can't do fractions.

[Turbulence]

Note that one reason we treat gambling like we do in the tax code is because America is very religious country and religious organizations have pushed for all sorts of limitations on gambling. I know some of the leadership at my church went absolutely crazy when a state-wide gambling proposal came up, and I'm talking about a very dull mainstream church. Given the fact that Americans exhibit higher religiosity than citizens in other developed nations, it seems like a gambling hostile tax code is something we just have to accept. Unless you are willing to advocate for more serious enforcement of laws preventing tax-exempt religious organizations from political advocacy....

I can tell you one thing: if Congress ever decides to seriously reform the tax code in a way that takes on any one of the 5 subsidies Seb brought up, there is no way on Earth they're going to alienate religious anti-gambling groups by tinkering with how gambling is taxed at the same time.

[Slartibartfast]

it is a very regressive and cynical tax on people who are not good at math

As was alluded to elsewhere in this thread, the lines of people buying lottery tickets here in Florida underrepresent, as an example, actuaries. It's a regressive tax on innumeracy.

So everybody's pet peeve gets included in the tax code, oh yeah, that's why it is the way it is today.

No, it's more like: the tax code is complicated enough without that it has to accomodate your gambling hobby.

My pet peeve is over-complexity, you see.

[hairshirthedonist]

So everybody's pet peeve gets included in the tax code, oh yeah, that's why it is the way it is today.

Should there be no tax treatment of gambling, because the one we have is fairly simple? Net winnings are income. That is all. (Since you seem to be complaining about the complexity of the tax code here, Marty.)

[jrudkis]

"Should there be no tax treatment of gambling, because the one we have is fairly simple? Net winnings are income. That is all. (Since you seem to be complaining about the complexity of the tax code here, Marty.)"

The tax treatment should be one of the following: gambling is taxable and deductible, gambling should be untaxed, or gambling should be illegal. Any other treatment is unfair.

[Ugh]

A simpler way to put my point RE: gambling, the tax code (or more specifically Congress and the IRS/Treasury) distinguishes between personal expenses, for which deductions are (generally) not allowed, and a trade or business, for which deductions are (generally) allowed.

Congress has decided that losses from gambling, for the vast majority of people, is a personal expense, and hence not deductible from other income. Yet, recognizing that it will, in fact, generate income in a non-significant number of cases, let's people reduce winnings by losses.

I'm not sure that the tax treatment of gambling would be any different if there were no religious people in the United States.

[hairshirthedonist]

A good policy to discourage gambling is making it illegal, not having state run lotteries with the worst possible odds, and preventing advertisement of gambling like tobacco.

I agree, but we were talking about how legal gambling is taxed. Current tax policy may discourage very little, but it still discourages, which is better than encouraging, even a little.

[Marty]

"Should there be no tax treatment of gambling, because the one we have is fairly simple? Net winnings are income. That is all. "

Like all sin taxes it is both unfair and regressive. I think that it is convenient to say net "winnings" are taxable, that just convenient excludes dealing with net losses.

It is a sin tax. Whether it is a sin or not a smart use of money, it offends the sensibilities of the religious and the and the "smart" people alike. It is one of the few things that they agree on.

FWIW, I haven't ever won enough to get taxed or lost enough to care, it is still a regressive tax on mostly people who aren't getting rich off of it anyway.

As for overcomplexity, not having it addressed in the tax code seems pretty simple.

[elm]

I never understood the purpose of taxing winnings from state-run lotteries. Many of Western Europe's communist hellholes don't tax lotto winnings. It seems like a way to exaggerate the size of winnings (if the state will take ~30% of the winnings back anyway).

I'm less certain about taxing other gambling winnings. My reservations come from the fact that poker is more a game of skill, regardless of how it's classified. Exempting poker winnings from taxation doesn't seem like a particularly good idea.

From what I've seen, gambling taxes don't do much to discourage gambling, least of all compulsive gambling. On the contrary, taxes and other state revenues from gambling make it impossible to abolish and difficult (politically) to discourage.

[jrudkis]

Elm,

That makes sense. Perhaps the solution is to tax skill games, and not tax random games.

I think you are comparing national games to state games when you talk about the tax implication, but the reuslt is the same.

[Tony P.]

Consider gambling this way: you purchase a paper asset (lottery ticket, playing card, stock certificate, CDS) in the hope of selling it for a higher price. The odds are different in each case; your potential ROI is different in each case; but the basic transaction is the same.

So: compare and contrast the tax treatment of various forms of gambling.

--TP

[Bernard Yomtov]

jrudkis,

it seems that gambling is treated as a separate business for everyone who partakes, but without the structure required for other businesses...so you can deduct the loss of gambling from your winnings, but probably not your travel to Las Vegas, hotel room, rental car, etc., that you could if you were there for a convention.

As ugh points out, gambling is treated just like any other hobby that you might occasionally make money at. If you sell your photographs, or wood carvings, occasionally you are allowed to deduct your expenses up to the amount of your income from the sales. You are not allowed to take deductions against other income.

Nor should you be, really. Think about it. You can spend an awful lot of money on a hobby. Do you think an amateur photographer ought to be able to deduct the cost of equipment, travel, workshops, etc. because he happened to sell one or two prints for a couple of hundred dollars? If I could do that I bet I could find some buyers in a hurry.

I'm not sure about gambling, but it is possible to take these deductions if you can prove that what you are doing is actually a business, not a hobby. The "safe harbor" is making a profit three years out of five, but you can show it other ways as well if you can't meet that test. Then you can deduct all associated expenses.

Again, I'm not sure if that applies to gambling, but I sort of suspect it does.

[jrudkis]

If you sell your photographs, or wood carvings, occasionally you are allowed to deduct your expenses up to the amount of your income from the sales. You are not allowed to take deductions against other income.

I think you should be able to deduct the cost of gaining the skills to sell the trinket. And you should be able to deduct those expenses across the taxable year. For the vast majority of people this is covered by standard deductions where it makes no sense to try and determine what the value is. However, if someone suddenly sells a totem pole for 100k, they should be able to deduct the costs involved in getting that skill. If it is a one shot deal, the government gets little, but if it is a new career, the deductions go away.

Or, maybe it is better that artists are born rich.

[Jacob Davies]

Bernard Yomtov: Do you think an amateur photographer ought to be able to deduct the cost of equipment, travel, workshops, etc. because he happened to sell one or two prints for a couple of hundred dollars?

Well, this actually brings up another sort of tax evasion, which is the miraculously-profit-free small business that just happens to write off the costs of most of the proprietor's living & consumption costs as business expenses, while the rest of us have to pay for stuff with post-tax dollars. Nice work if you can get it.

Hard to measure since by definition it involves avoiding money getting to the point of being counted as income.

[Tony P.]

Russell: Tony, how much would we have to raise top marginal rates on incomes over $100K to get $430B?

I don't know offhand. It would certainly matter whether we stick with the current tax brackets or not. "Incomes over $100K" span a roughly 50,000:1 range in this country.

Crudely, let's say "income over $100K" describes about 5% of about 150 million returns, so roughly 7.5 million of them. To raise $430B we'd need to collect a bit less than $60K per return -- if we treat the increment as a head tax.

On the other hand, the same arithmetic says that a bit less than $60K per return is what the Treasury is currently shelling out to people in the $100K+ category, if we treat the mortgage deduction as a subsidy.

--TP

[Bernard Yomtov]

Jrudkis,

I think you should be able to deduct the cost of gaining the skills to sell the trinket.

But there is no difference between "the cost of gaining the skills to sell the trinket," and the cost of gaining the skills to be a neurologist, or an engineer. If you want to advocate favorable tax treatment for educational expenses, I'm all ears, but I don't see why there should be a distinction based on the particular activity one trains for.

[CharlesWT]

Deductions for dependents under 18 (perhaps 21) years of age should be removed from the tax code.

[bobbyp]

Seb posts on tax reform....thread on the tax treatment of gambling wins/losses breaks out. Doth do the internets go viral, either that or there are indeed a lot of closet gamblers here.

Most organized legal gambling activities have clearly calculable expectations. The expectation either favors the house (blackjack, slots)or is net zero (roulette). When the house/(bookie) takes their vig either by levying a tax on the bet (baccarat, sports betting)or fixing the odds to change that expectation in their favor (roulette, craps), the expectation goes negative for the player. Since the income goes to the house, that is where it should be taxed....freeing our overworked IRS agents to pursue actual tax cheats like, well, just about anybody with a net worth over a million or the numerous tax scofflaws who write off their personal auto or that trip to Vegas as a "business expense".

Just sayin'

[Hartmut]

Not up to date on gambling laws over here but in the past 'real' gambling (casinos) was only allowed at places beyond a minimum distance from your home address (i.e. you have to drive to another town to do it).
Casinos were also either state-run or with narrow licences that took most of the earnings and putting it into the state treasury.
'Tax-free' lottery wins may just hide a pre-tax, i.e. the money is taxed before it goes into the jackpot.

[russell]

Yeah, the left turn down gambling alley is kinda weird.

Maybe I'm missing something but if I read this right and it is, in fact, the relevant document, the policy appears to be:

If you make money gambling you pay taxes on it. Depending on the type of gambling, the taxes may be withheld, or not. In either case they're taxed as plain old income.

If you win some and lose some, you can offset your winnings by your losses, however this is limited to the total amount of your winnings. You can't claim negative gambling income.

All in all, this seems pretty straightforward and reasonably fair, to me.

And yes, lotteries are regressive, and generally a bad financial deal for the folks involved. Some folks just play for fun.

[Slartibartfast]

Deductions for dependents under 18 (perhaps 21) years of age should be removed from the tax code.

I could just as easily assert that deductions for dependents OVER 18 should not be allowable. And I'm right, because I say so.

is net zero (roulette)

Depends on how you bet, I think. But IIRC the house has a slight edge in roulette; Wikipedia discusses this in detail here. Not that Wikipedia is dispositive, but if they've got it wrong it'd be interesting to see how.

[Marty]

While it was a left turn into gambling, the discussion is illuminative because it points out the problem with our tax system. The problem is that the tax code has been used to implement social policy.

Everything discussed here, i.e. hidden subsidies etc., is essentially burying a social agenda in tax code. The fundamental desire by some to advantage the wealthy or the poor, redistribute income, deter or encourage particular behaviors etc. is why we can't implement a tax system that makes sense.

So everytime someone says "it impacts behaviors that I like (or don't like) so that tax is ok with me" (including me) we have failed to simplify the tax code.

So, as pointed out in a few places, we should unhide subsidies and stop trying to further social agendas with the tax code if we want it to be simple and fair.

Gambling just happens to be a simple example of just taxing something because not many people will object, as difficult as it is to actually write a reasonable justification for defining it as income,IMHO.

[Ugh]

The house has a slight edge, and sometimes more than a slight edge, in every single game, save blackjack and then it doesn't have it only if the it doesn't use continuous shuffle machines and you are good enough at counting cards and changing your bet accordingly to turn the odds in your favor (without being caught).

[CharlesWT]

"I could just as easily assert that deductions for dependents OVER 18 should not be allowable."

Dependents over 18 are likely to be people who unable/unwilling to care of themselves who might otherwise depending on government directly to take care of them. Whereas deductions for dependents under 18 just subsidizes having children. Aren't there too many people in the world already? I would go along with doing away will all dependent deductions.

[Marty]

While I have very little admitted experience in the dens of iniquity that foster such behavior, I believe the best odds in the house are on the pass line at the craps table where the house edge is only 1.41%, or so I've heard.

[hairshirthedonist]

Like all sin taxes it is both unfair and regressive. I think that it is convenient to say net "winnings" are taxable, that just convenient excludes dealing with net losses.

Regressive, maybe. Unfair, I'd say only to the extent that it's regressive. We could make the tax code more progressive if you like to mitigate this.

Either way, you like to complain about the complexity of the tax code, yet you are advocating a more complicated tax treatment for gambling. Losses are spending on entertainment. Net winnings are income, the chance of which makes gambling entertaining and, to some people, worth spending money on. But net winnings are still income and net losses are still spending, not on basic necessity or business, therfore not deductible. How hard is that to understand?

[Marty]

"Either way, you like to complain about the complexity of the tax code..."

I do like to complain, and no I don't think I am making it more complex by saying you shouldn't tax it. Seems simpler to me.

[hairshirthedonist]

Gambling just happens to be a simple example of just taxing something because not many people will object, as difficult as it is to actually write a reasonable justification for defining it as income,IMHO. (Somehow I didn't catch this at first.)

Income: in + come, as in money coming in. Winning at gambling = money coming in or money incoming or income. You're getting money, you know, like receiving it. How is it not income? What is it if it is not income?

Generally, when you are getting money, the default is that it is income, and taxable as such. The tricky part is explaining why it isn't taxable income. Let's see your explanation, Marty.

[hairshirthedonist]

I do like to complain, and no I don't think I am making it more complex by saying you shouldn't tax it. Seems simpler to me.

Previously, we were discussing making net losses deductible, and that's what I thought you meant. So, yeah, just doing nothing at all would be simpler. But I don't see what makes winning at gambling not income, so I don't see why it shouldn't be taxed as such.

[Marty]

"The tricky part is explaining why it isn't taxable income"

Lots of money coming in shouldn't be taxable, gambling, gifts, inheritance,etc.

[hairshirthedonist]

That's not an explanation. That's simply adding gambling to a list of things that aren't taxable. There are established reasons for those other things not being taxed. You need to establish reasons for adding gambling to the list.

I had a funny thought regarding allowing the deduction of net gambling losses. I'm going to open a casino in my house. There will be only one game: The Matress Game. It will work like this: there's a matress into which you can put money, in which case you've lost that money, or you can take money out, in which case you've won that money. I'll probably end up losing some money in years where my income is high and winning some money in years where my income is low. That'll help with my taxes with more flexibility than an IRA.

[russell]

Gambling just happens to be a simple example of just taxing something because not many people will object

A lot of tax vehicles are chosen for exactly that reason. And pretty much every tax regime we've ever had in this country has supported some social or economic agenda or other. We ran the country on tariffs from the early days until the early 20th C, and they both raised revenue and encouraged the development of domestic industry.

There's always an agenda.

[Jesurgislac]

Marty: Lots of money coming in shouldn't be taxable, gambling, gifts, inheritance,etc.

So it's okay to tax people who have little money, but absolutely wrong, in your mind, tax people who receive "lots" of money?

That just sounds like the basic right-wing principle of "don't tax the rich", Marty.

[Marty]

"So it's okay to tax people who have little money, but absolutely wrong, in your mind, tax people who receive "lots" of money?"

You should probably read all the comments to understand the discussion so your comment wouldn't be so far off my point as to look completely ridiculous.

[Slartibartfast]

The problem is that the tax code has been used to implement social policy.

To the extent that that is true, simplification of tax assessment on those monies that are incoming seems best and least social-policy-ish to me.

You might think gift taxes are stupid, but if you take them out of the picture, someone will quickly realize that their salary can be replaced by a regular series of gifts.

A tax code should be both simple and not easily circumventable. Your judgement calls fail the second test.

[Slartibartfast]

Dependents over 18 are likely to be people who unable/unwilling to care of themselves who might otherwise depending on government directly to take care of them. Whereas deductions for dependents under 18 just subsidizes having children. Aren't there too many people in the world already? I would go along with doing away will all dependent deductions.

Ah, that's what I was looking for: rationale. Thanks.

Although I have some sympathy for not subsidizing reproduction, having over-age-18 dependents in your household is also a choice. Why is one choice to be favored under your proposed tax scheme, while another one isn't?

[Marty]

"A tax code should be both simple and not easily circumventable. Your judgement calls fail the second test."

I am pretty sure that a simple and eloquent definition can be determined that establishes a difference between a payment and a gift. We differentiate between those things now for tax purposes, what would be harder about that differentiation going forward?

[Slartibartfast]

I am pretty sure that a simple and eloquent definition can be determined that establishes a difference between a payment and a gift.

I am not so sure. So: impasse.

We differentiate between those things now for tax purposes, what would be harder about that differentiation going forward?

Right now, IIRC, gifts are taxed as regular income, so there's no reason for anyone to take their income as a gift. If you take gift taxes out altogether, the tax on gifts is zero, so incentive will occur, and where there's incentive, there are people who will act on it. It's human nature.

[Marty]

"Right now, IIRC, gifts are taxed as regular income, so there's no reason for anyone to take their income as a gift. "

I am not sure but I do think there are limits and exemptions specific to gifts. I don't believe a lot of people are trying to sneak their income by as a gift to avoid being taxed on all of it.

[Slartibartfast]

Also, IIRC the tax burden for gifts is on the giver. Take gift tax away, and the incentive not to gift in lieu of pay also goes away.

[elm]

A tax code should be both simple and not easily circumventable.

Looking at the table of contents for the tax code (note: pretty large file) it seems that a large fraction of the code exists to make it difficult to circumvent.

For example, TITLE 26, Subtitle A, CHAPTER 1, Subchapter A, PART IV, Subpart D, Sec. 40. is about 1800 words which define -- in excruciating detail -- "Alcohol used as fuel" for tax purposes.

I doubt anyone finds this complexity inherently desirable, but it prevents the Jack Daniels company from claiming a tax credit for its whiskey production.

[Marty]

"but it prevents the Jack Daniels company from claiming a tax credit for its whiskey production."

so without that credit we could save 1800 words.......

[Slartibartfast]

Hence the necessity for simplicity, which in my book means a minimum of devices wherein special interests have voted themselves tax breaks.

Corporate income tax is another issue entirely & should, IMHO, be tackled separately.

[hairshirthedonist]

I am not sure but I do think there are limits and exemptions specific to gifts.

The annual exclusion for gifts is $11,000 (2004 - 2005), $12,000 (2006 - 2008), $13,000 (effective January 1, 2009 per IR 2008 -117).

[Bernard Yomtov]

The expectation either favors the house (blackjack, slots)or is net zero (roulette).

No. The house has a very clear 5.26% edge in roulette. The easy way to see this is to note that there are 38 numbers on the wheel: 1-36, 0, and 00. 1-36 are divided equally between red and black, while 0 and 00 are green.

The payoff on any bet you make is calculated as if there were only 36 numbers. If you bet on 22 (Extra credit question: Why did I choose that number?) for example, and it comes up, you collect at 35 to 1, rather than the 37 to 1 that would be the actuarially fair payoff. So if 38 bettors each bet one dollar on different numbers the house pays $35 to the winner and collects $37 total from the losers, thus making a $2 profit. That's 5.26% of the total amount bet.

[Ugh]

Bond, James Bond?

[Ugh]

Gift Taxes: The recipient of a gift owes nothing. Thus, Bill Gates could give, say, Hilzoy $8 billion (and please do, Bill), and she would owe no tax. Bill, OTOH, as the giver, would owe a substantial tax on such a gift.

The gift tax is a backstop to the estate tax (though I suppose you could view that in the reverse), with the exception that you can give $13k/year to specific individuals without incurring the tax (and also, IIRC, can give a larger amount but it takes away from your estate tax exemption).

[Slartibartfast]

The annual exclusion for gifts is $11,000 (2004 - 2005), $12,000 (2006 - 2008), $13,000 (effective January 1, 2009 per IR 2008 -117).

Sure. But if you make gifts no longer taxable, then those are no longer in effect, so: gifts unlimited!

[hairshirthedonist]

so without that credit we could save 1800 words.......

Sure, but what would that do for, say, you, Marty? Are you navigating that part of the tax code when filing? The tax code covers a wide range of subjects, but you only need to concern yourself with the parts that apply to your sitution. What percentage of Americans do you think need to apply the "Alcohol used as fuel" piece?

I do agree that the tax code could use some simplification, but simplicity isn't the only thing to consider. It's also worth considering the practical effect of a given part of the tax code on wide swaths of filers and, given that, how worthwhile that part of the tax code is. "Simpler is better" is an "all other things being equal" proposition, not a sole driver.

Now, maybe there is a compelling argument for getting rid of those 1800 words, but it can't simply be "getting rid of 1800 words."

[Rob in CT]

I'm all for simplicity, though simplicity and clarity are often in conflict.

I'm generally on board with the idea that we should pull out the deductions/hidden subsidies and, if we wish, be straight-forward about subsidizing something. I also hope that simplicity would make tax avoidance harder.

In theory... sure, ok. I'd get hit (slowly, as these things are phased out) by the removal of the mortgage deduction, the employer-provided health insurance deduction, the 401(k) thing and the capital gains change. I get back simplicity and a lower income tax rate, and that could be designed such that in the end my tax burden doesn't really chance (ah, but would it?). Theoretically, I might see slightly improved personal and governmental decision-making happening around me, which would be nice.

But I think we all know people will fight tooth and nail for all these deductions. This would absolutely be attacked as a socialcommiefascist scheme designed to attack hard-working American homeowners (or somesuch). You, the plan's author, would be classified as being somewhere to the left of Trotsky.

[Bernard Yomtov]

Bond, James Bond?

Bzzzt. Wrong, but it is a movie reference.

[Slartibartfast]

Wrong, but it is a movie reference.

Play it again, Sam.

[Bernard Yomtov]

Play it again, Sam.

A winner, but with a point off for the misquote.

I see that Slarti understands the fundamental things.

[bread & roses]

I don't think you can have a tax code that doesn't carry out a social agenda. A head tax is incredibly regressive and punishes the poor. A flat tax is also regressive and increases inequality. A progressive tax can never be so perfectly dialed in as to leave everyone's incentives equal to what they would have been in some fantastical tax-free universe.

And that's just the rates. As far as deductions go: every deduction is a social agenda. Deducting dependents encourages people to have children; not deducting them makes people with children have more tax on their disposable income than those without (on top of that they probably have less disposable income). Even deciding who is a dependent has social implications. There is no such animal as a "fair" "simple" tax that has no social policy implications. Can't be done.

So, this is an interesting discussion- and I do agree that fewer deductions as a general rule would be better. I would like the tax code to implement broad-based social policy rather than narrower (the EITC is broad; eases poverty. The alcohol-used-as-fuel exemptions are narrow).

I like the idea of direct subsidies as opposed to sticking things in the tax code. But I think it might be harder to get those subsidies to lower-income people. For example, energy subsidies- there are tax credits for various energy-saving home improvements- reflective roofs, solar power, super-insulated windows. Claiming those credits is easy, and all the verification of identity, even the depositing of the check, is easy to administer because it's part of something that almost every homeowner has to do anyway- file a tax return. There are other subsidies offered by our city and county, for things like buying efficient washing machines, and most people don't claim them, because they don't know about them, or they have to apply, and most people who don't run their own business don't keep track of things like that very well.

I could argue that this is a good thing; the people to whom the subsidy is irrelevant don't notice it and we don't waste money subsidizing behavior that would have happened anyhow. But somehow a program that works better when people don't know about it seems problematic.

[bread & roses]

I left out part of my argument, which is my observation (sorry, no data), that richer people tend to hire lawyers and accountants who can keep track of all the little ways they can use subsidies and incentive programs and such to their advantage.
(like the great observation above about tax-shelter businesses that make tiny profits and write off the owner's expenses. It's possible for a Wal-Mart employee to have one of those, but she won't get much out of it, since she has low-to-no tax liability, and she doesn't have the kind of life that makes it easy- unlike, say, a Goldman Sachs employee)
So if you're offering an incentive program, I think you have to make it aggressively easy for the low-income, low-education, and non-accountant-hiring part of the population to use, or you will automatically advantage wealthier people. Tax credits fill that bill pretty well.

[bobbyp]

While I have very little admitted experience in the dens of iniquity that foster such behavior, I believe the best odds in the house are on the pass line at the craps table where the house edge is only 1.41%, or so I've heard.

True for table games, but there are some slots that have even better payouts if you can stand to play slots.