AskDong

I finally got around to filing my taxes for 2008.   I generally owe taxes, so I’m never in much of rush to file them.  Every year, my taxes become more complicated to my general displeasure.   I’m happy to pay my fair share in taxes.  I don’t feel unjustly burdened by the actual amount of taxes I pay, but I am becoming more irate about the overly complex tax code.

I accept that much of the added complexity is of my own making.  My taxes have steadily gotten more complicated over the years.   When Ifirst graduated from college, my taxes were blood simple.  I didn’t have a mortgage, owned nothing in terms of stocks, and had no money on which I earned interest.   Today, it’s a much different story:

1. I have a personal mortgage
2. I sold over 20 different securities last year (mutual funds, stocks, options, etc)
3. I earn taxable interest, federal exempt interest, and federal and state exempt interest
4. I own a rental property
5. I have business income - I earn about $40 a year from AskDong.com
6. I’ve steadily increased my charitable giving

Printed, my taxes were over 45 pages, and my taxes could easily be more complicated.    I’m single and I have no dependents, which automatically makes my taxes more simple.   The Alternative Minimum Tax does not apply to me.    Even with the rental property my taxes shouldn’t be this complex.

The problem is the tax code has become increasinly obtuse with every passing year.   Half of my taxes are taken up by calculations that only determine that I don’t need to make those calculations.  Student interest has not been a deductible expense for me in years.   As my salary has increased, I’ve given up more and more deductions.  I’m OK with not having those deductions.  What I’m not OK with is the shoddy and fragmented tax code that all us have to spend undue hours wrestling with.   There are too many different phaseouts for far too many different deductions.

Policy makers have fallen in love with carving out different pieces of tax code with the best of intents, and pitifully poor execution.  Who doesn’t want to encourage higher education with deductible interest?  Phasing out that deduction make sense as it should only be benefitting those who really need a leg up.   I may not have a problem with each specific aspect of the tax code, but taken as a whole the tax code is bloated and confusing.  

I spent about 4 hours this past year doing my taxes, not including all the time I’ve spent over the past year making sure I had records.  There are deductions I missed because I couldn’t find receipts.    There are dates for stock purchases I had to make my best guess on because I no longer have exact records.    At the end of the day, I’m very conservative with my taxes.  I’d rather pay slightly more in taxes,  and despite TurboTax indicating I have a very low audit risk, I still  worry about it.  

Taxes should not have to be as complicated as it has become.   I’ve always believed the better the tax code the simpler it is.   Lump all deductions in one category.   Phase all of them out as necessary, but all at once instead of provisions hitting at different points.  Better yet, increase the standard deduction so that most people don’t even have to worry about deductions.   Unify all the different retirement vehicles so everyone gets X dollars to invest tax deferred (401k, IRA, Simple IRA, etc) and Y dollars tax free (Roth).   The Government needs to tackle the issue of Tax Reform, not because it needs to raise or lower taxes, but because it needs to make the tax code understandable and more accessible to the average tax payer.

One Obama’s tax proposals meeting the strongest opposition is Obama’s plan to cap itemized deductions for some of the top income earners at 28% .  I have some major gripes about this proposal, but not necessarily for all the same reasons than many of the lawmakers who are now voicing opposition.

Basically, the plan would cap many of the most popular deductions for high earners at 28%.   Mortgage Interest, charitable contributions, and medical expenses would fall under this cap.   Currently, tax filers benefit from the deductions at their marginal tax rate.  Let’s say instance say I made 1 million dollars, and fell in the top tax bracket, 35% (set to rise to 39.6% in 2011).    If I donated 100,000 to charity, I would effectively be able to reduce my taxes by 35k.  The charitable donation is effectively tax free.  Under the proposed rule change, I would in the future only get a 28k offset to my taxes.

I don’t like this plan.  I’m not opposed to higher taxes in order to better balance the budget and have long advocated that mortgage interest not be deductible at all (I prefer a higher standard deduction to offset housing costs).  I primarily don’t like this plan because it adds more complexity to a tax code that’s already become much too complex with different deductions and phaseouts that apply only under certain conditions.  Complexity benefits those with the best lawyers, and accountants while creating headache and confusion for the average american.   The simpler the tax code, the more easily individuals can make sound economic decisions.

This tax code change would affect very few tax payers.  Not only does one have to be in the top income brackets, but one also has to be able to evade the Alternative Minimum Tax (AMT).  Under the secondary AMT code, deductions are effectively already capped at 28% as that’s the AMT tax rate.  Many of the top income families in high tax states are already hit by AMT rather the standard tax code.   It’s really the top of top that would be hurt by these tax code changes.

While my primary problem with the change is the added complexity, I do have issue with not allowing charitable deductions to be fully deductible.   While I think most people would still give despite the change, I see no reason to give any discouragement to people to give to causes that they believe in.   That said, I believe there’s rampant abuse by some of the top top earners (such as media stars and athletes) who often set up foundations more of as tax dodge than true giving.   The fact is that the tax code needs an overhaul, and a major one at that.   I would like to see Obama take the bull by it’s horns, and make some hard choices that are likely to piss off both the political left and right rather than making one off tweaks.

I made few comments to Dave Henderson’s post on the Econlog on the tax credit phaseout of Obama’s $400 tax credit. Dave asserted that the tax credit effectively raised the marginal tax rate for those who do not qualify for the tax credit.   At first, I protested as I incorrectly interpreted his use of marginal.  When I see marginal and taxes together in any sentence, I immediately think of the top tax bracket.   Oops.   You can read my comments there, but let me expound here a little on what Dave’s talking about. I will only consider a single filer, and not worry about the complexities that come with deductions.

What Dave Henderson’s speaks to is that odd kink in the effective marginal tax rate caused by Obama’s $400 tax credit.  In the phaseout range, a tax filer’s marginal tax rate is actually higher than the base marginal tax rate.

At the start of the phaseout range, $75,000 the base marginal tax rate is 25%.   So for the 1st dollar earned after that I get taxed at 25% as I would normally be, but it addition I would also have to give up an additional .02 cents of the earned tax credit given the phaseout.   Effectively I would be paying 27 cents in total taxes for that dollar over 75,000,  making my effective marginal tax rate 27% instead of 25%.    Once you’re in the next tax bracket that begins at 82,250, you would be paying effectively 30% instead of 28%.

This tax credit introduces an odd kink in the effective marginal tax rates that means middle income earners in the $75,000 - $95,000 will be paying more a on a marginal basis than higher income earners who are completely phased out of the tax credit.

However, one thing that should be kept in mind despte the marginal tax rate increase in the phaseout band, nobody is actually paying more in taxes.  Those in the phaseout band are benefitting from the lower effective tax rate at the lower bands of their income.

I’ll save my feeling on how I feel about progressive taxation and the impact of small marginal tax increases for another day.   In truth, I think I’ve already talked about that previously.  I generally favor a progressive tax system, and believe that small increases in the marginal tax rate at the high end is unlikely to curtail productivity.   Of course my actual opinion is far more complicated than that.

My perspective is different than Dave Henderson’s, but I do believe that introducing a kink in what I consider a middle income range of salary is less than ideal.   That’s income range in which workers are likely to have more control on how much they earn either by working overtime, or expaning their business if self-employed.   I would’ve preferred a slight reduction in the lower tax brackets with a slight increase in the top bracket.   I don’t believe people at the top top bracket would curtail their work for a .1% increase in their marginal tax combined with a reduction of the 15% bracket down to 14.5%.    However, it’s much easier to implement a tax credit than to make broader changes to the tax code.

I’ve been a long term user of TurboTax.   I filed last year using it, and have done so for the last 9 years.  I’m a captive market.  Turbotax imports all my information from last year, and makes my filing a relatively quick matter.  I pay $60-$70 every year for this convenience.

I thought I would get a head start on my taxes this year by purchasing TurboTax right now.   I also figured that the best way for me to purchase it would be to download the software.  Intuit sells the product online as a download.  I brought the premiere version last year, and plan on doing so again. It’s $89.95, and includes 5 free federal filings.   Intuit still charges $19.95 for each state filing which I believe is increase from last year’s $14.95

As I said before the TurboTax is a cash cow for intuit even with the slightly lower total filing charges.   However what bothers me is that currently it costs me more to download the product than to buy a physical copy from Costco.  Costco sells the product for $62.95 online for the physical copy.  The best download price I can find is from the Amazon store which sells it for $66.49 versus $68.99.  Apparently according to the 1 review on Amazon, Amazon too was selling the physical copy for less money.  It’s not anymore.   I’m astounded that the download copy is not at a more significant discount.  What’s worse for me and many other users is the face that Amazon only sells Windows version for download.  I cannot download the Mac version anywhere but from the Intuit site.  At Intuit the download version sells for the same price as the physical version, $89.95.  This is substantially more expensive than the physical copy I can buy at either Costco or Amazon.

Companies should be incentivizing consumers toward choices that are better for their bottom line, and the environment.  Downloaded software is winner on both these counts.  Maintaining inventory, and shipping a physical product is more expensive than allocating hard drive space towards serving copies of software.  Right now, I’m confronted with a decision of spending $20 extra for a product I prefer (less trash and packaging) or putting my wallet ahead of my green credentials (which aren’t too great as is).  I don’t mind paying extra for products that I believe are more environmentally friendly.  What I mind is paying more for environmentally friendly and costs less for the manufacturer.

Obama has begun to to announce details of his stimulus plan. Nearly 40% of his plan will consist of tax cuts.   As a result criticsm has come from the left, and opposition remains on the right.   While the proof will be in the pudding, a stimulus plan that includes both tax cuts and infrastructure spending seems reasonable enough.   However, the left believes any tax cut is purely pandering to the right while the right believes that the tax cuts are not enough or do not benefit the real cogs of the economy, the top earners.   Given that many of these top earners have been princes of Wall Street, I do not believe that one’s value to the economy is truly a function of one’s pay.

Obama’s very centrist play so far has exposed the critical flaw in today’s political landscape.    Compromise has become a dirty word, and idealology trump ideas. “Liberals” believe “Conservatives” are devoid of any good ideas, and vice versa.   The fact is that both liberals and conservatives have good ideas about how to best right the economy.  Tax cuts are arguably a better way to stimulate the economy from a cost benefit perspective.

The fundamental crux for arguing for a tax cuts instead of stimulus spending is that individuals and the free market are better at allocating resources than the government.   I do believe in general it’s better to let the market decide where to spend money.  However, the current fear is that consumers will choose not to spend.   This is legitimate worry, and one thing I applaud in the Obama tax plan is the tax breaks directed towards business.   In addition, I do believe there are areas where the Government is the only entity capable of spending money.  National infrastructure such as roads and bridges are the obvious places   However, I think the Government can have setting industrial policy, and funding initiatives.   Much of the research that becomes tomorrow’s technology is already funded through government grants.    There is room for Government in the coming months to do more in the light of the need for a fiscal stimulus.