So far, the tax code has been a major talking point in the 2016 presidential race, and for good reason. Taxes are both the biggest destroyers and creators of wealth. Rare is the American citizen who does not want more wealth, so many are looking to change the tax code in favor of a flat tax, allowing everyone to pay the same flat percentage rate. While this change may seem simple at first glance, the tax code is long and complex, and changing it as drastically as a flat tax would lead to unintended and severe consequences.
Talking about simplifying the tax code, as many presidential candidates are currently doing, is like talking about simplifying the human body. The human body is the most complicated organism on earth. While maintaining the health of the human body is often as simple as eating right, exercising and reducing stress, the reason health is simple to maintain is because the body itself is so complicated. The same principle applies to the tax code. While it is long and complex, the complexity makes for a stable and relatively easy economy to maintain.
The tax code is essentially a guide that teaches you how to not pay taxes.
This guide incentivizes you to put money in certain places, like charity, oil and gas, or low income housing, so you do not have to pay taxes on them. We all hate paying taxes, and government officials know that, so they use tax incentives to motivate the American public to put their money in certain places. With the tax code as it is now, the economy is directed by the code’s provisions or incentives. Whether you realize it or not, what you do with your money can be drastically impacted by the amount of taxes that you pay. Implementing a flat tax would remove the motivation to put money in certain industries, leading to the likely demise of those industries.
A good example of how changing a tax policy can drastically affect the economy is the Savings and Loan Crisis from the 1980s. Investors were given tax benefits for investing in real estate. These investors would make a five-year funding commitment. However, when their tax benefit was eliminated in 1986, many investors stopped their funding. As a result, projects collapsed and the economy spun out of control. This was the result of one change in the tax code. Imagine the results of changing the entire code.
What many politicians fail to recognize, or at least acknowledge, is that if they change the tax laws, they will have to change the economic ecosystem. Currently, many people go into business, at least in part, for the tax breaks. If those tax breaks are eliminated with a flat tax, who will go into business? How will the economy function if there are no employers, only employees?
A flat tax would create an estimated ten to fifteen-year disruption before the economy could settle into a new ecosystem. It would likely be a difficult and uncomfortable decade as the economy shifts, and it is important to consider how that shift will impact various industries. If no one is incentivized to invest in low-income housing, will there be any low-income housing? If not, what will happen to those Americans living below the poverty line, and what affect will an increased number of homeless citizens have on the overall economy?
Instead of drastically, and perhaps recklessly, rewriting the tax code, the most effective way to improve tax rates is to change your own economy. Our American economy is an aggregation of everyone’s personal economy. If you want to change the outcome of your economy, and the American economy as a whole, find a tax advisor and follow their advice.