A Fine Mess

1. The U.S. tax system is a complex, costly mess compared to other rich nations.

It might be funny if the whole taxpaying process in America weren’t so maddeningly expensive, inefficient, and time-consuming.

A national burden. The U.S. tax system is notoriously complicated, imposing a massive burden on taxpayers in terms of time and money. In 2015, Americans spent over six billion hours preparing and filing returns and paid billions in fees for software and professional help. This complexity is not accidental; Congress often adds complicated clauses, sometimes even in legislation supposedly aimed at simplification.

Compliance costs. The sheer difficulty of navigating the tax code means most Americans cannot file on their own.

• Only about 10% of taxpayers do their own returns.
• 60% hire preparers like H&R Block.
• 30% buy software like TurboTax.
  This results in significant compliance costs, estimated at hundreds of billions of dollars annually in lost working time and fees, making tax preparation a major U.S. industry.

International contrast. This level of complexity is unique among developed nations. Countries like the Netherlands, Japan, and the U.K. have systems designed for simplicity, where filing takes minutes or is even automatic. The U.S. system, in contrast, feels like it's at war with its taxpayers, undermining trust and voluntary compliance.

2. Americans are undertaxed compared to citizens in other developed democracies.

Relative to other countries like us, the United States is One Nation, Undertaxed.

Lower overall burden. Despite common complaints, Americans pay significantly less in total taxes (federal, state, local) as a percentage of GDP than citizens in most other advanced, free-market economies. In 2014, the U.S. tax burden was 25.88% of GDP, well below the OECD average of 34.18% and far less than countries like Denmark (49.58%) or France (45.49%).

Specific taxes lower. This lower overall burden extends to most specific taxes as well.

• Taxes on labor (income, Social Security, Medicare) are lower.
• Top income tax rates kick in at much higher income levels in the U.S.
• Capital gains taxes are lower than in many peers.
• Sales taxes (VAT/GST) are non-existent nationally and lower locally.
• Gas taxes are dramatically lower than in Europe or Japan.
• Tobacco taxes are also lower.

Corporate tax exception. The one clear exception is the corporate income tax, where the nominal rate (35%) is among the highest. However, due to numerous loopholes and avoidance strategies, the effective rate paid by large U.S. corporations is much lower, though still often higher than in competitor nations.

3. Taxes serve multiple purposes beyond just funding government.

“Taxes are what we pay for civilized society,” he explains, “including the chance to insure.”

Funding public goods. The primary purpose of taxes is to finance government activities and public services that benefit society collectively, like infrastructure, defense, education, and safety nets. Historically, governments have moved from simple duties (like customs) to more complex internal taxes as economies developed.

Shaping behavior. Governments use taxes to encourage desirable actions and discourage undesirable ones.

• Encourage: Deductions/credits for charity, homeownership, education, retirement savings, electric cars.
• Discourage: "Sin taxes" on tobacco, alcohol, and increasingly, sugar, to offset health costs and reduce consumption.
  While these can nudge behavior, they also add complexity and can be inefficient or unfair, sometimes benefiting the wealthy most.

Promoting fairness and legitimacy. Taxes can be designed to redistribute wealth, ensuring the rich contribute proportionally more, a principle dating back to biblical times. A tax system perceived as fair enhances the political legitimacy of the state and can foster better citizenship, as seen in countries where tax agencies are respected and compliance is high.

4. Broad Base, Low Rates (BBLR) is the principle for effective tax reform.

In fact, it’s so simple that the economists generally reduce the essential formula for good taxation to a four-letter word: “BBLR.”

The core idea. BBLR stands for Broad Base, Low Rates. It means taxing as much income, sales, or property as possible (broad base) allows for lower tax percentages (low rates) while collecting the same revenue. This principle is widely endorsed by economists and international financial organizations like the World Bank, IMF, and OECD.

Benefits of BBLR.

• Neutrality: Low rates are less likely to distort economic decisions, allowing them to be based on business or personal sense rather than tax implications.
• Simplicity: Eliminating numerous exemptions, deductions, and credits simplifies the tax code for both taxpayers and collectors.
• Fairness: A broad base reduces the perception that special interests benefit from loopholes, making the system feel more equitable.
• Compliance: A simpler, fairer system with lower rates can increase voluntary compliance and reduce the incentive for costly avoidance schemes.

Successful examples. New Zealand dramatically reformed its tax system based on BBLR in the 1980s, eliminating many preferences and cutting top income tax rates significantly while maintaining revenue. The U.S. also moved towards BBLR in the Tax Reform Act of 1986, cutting top rates by eliminating loopholes, a reform widely admired globally.

5. U.S. tax expenditures (loopholes) are costly, unfair, and complicate the system.

“If tested in direct expenditure terms,” wrote Stanley Surrey, a renowned tax scholar at Harvard Law School, “many tax incentives will be seen as either inequitable—often to the point of being so grossly unfair as to be ludicrous—or ineffective.”

Hidden spending. Tax expenditures are provisions like deductions, exemptions, and credits that reduce government revenue, effectively acting as backdoor spending programs. Coined by Stanley Surrey, this concept highlights that these tax breaks cost the government money, just like direct appropriations. In 2014, U.S. tax expenditures totaled over $1.17 trillion, exceeding the budgets of major programs like Social Security or defense.

Inequitable distribution. Many tax expenditures disproportionately benefit the wealthy. Deductions, for instance, save more for high-income taxpayers in higher tax brackets than for lower-income individuals. This creates a reverse Robin Hood effect, where those who need help least receive the largest government subsidy through the tax code.

Complexity and abuse. The hundreds of tax expenditures add immense complexity to the tax code, requiring detailed record-keeping and complicated calculations. They also facilitate avoidance and fraud, as seen with "rifle shot" provisions benefiting specific entities or complex schemes to exploit loopholes. Eliminating these costly and often indefensible giveaways is crucial for simplifying the code and lowering rates.

6. Popular deductions like mortgage interest and charity are inefficient and benefit the rich most.

Those who least need help get a subsidy, while those who most need it get nothing.

Costly giveaways. Some of the largest and most popular tax deductions are also major tax expenditures that cost the government billions in lost revenue annually.

• Mortgage interest deduction: Costs about $100 billion/year, primarily benefiting upper-bracket homeowners.
• Charitable contribution deduction: Costs about $50 billion/year, with the largest benefits going to wealthy donors who itemize.
  These deductions are often defended as encouraging good behavior (homeownership, generosity) but are inefficient ways to achieve these goals.

Ineffective incentives. Studies show these deductions have little impact on the behaviors they are meant to encourage. Homeownership rates are similar in countries with and without a mortgage interest deduction. Charitable giving levels in the U.S. haven't significantly changed when tax rates (and thus the value of the deduction) have fluctuated. Most people give to charity or buy homes for reasons other than the tax break.

Unfairness and complexity. Like other deductions, these popular ones disproportionately benefit the rich and those who itemize, leaving many average taxpayers with little or no benefit. They also add complexity, requiring detailed record-keeping and contributing to the overall burden of filing taxes. Other countries have successfully limited or eliminated these deductions without negative consequences for homeownership or charity.

7. Flat taxes simplify rates but can increase inequality and revenue challenges.

“A flat-rate tax would shift the tax burden from the richest taxpayers to those in the lower brackets.”

Single rate appeal. The flat tax, where everyone pays the same percentage of income, is promoted for its apparent simplicity and fairness. However, this simplicity often applies only to the rate structure, not the calculation of taxable income, which can still be complex depending on allowed deductions.

Shift in burden. The most significant impact of a flat tax is the redistribution of the tax burden. It results in a major tax cut for the wealthiest, who currently pay higher progressive rates, and a tax hike for many lower and middle-income taxpayers, increasing economic inequality. This shift is a primary reason for its appeal among high-income individuals and their political advocates.

Revenue challenges. Flat taxes often generate less government revenue than progressive systems, particularly if set at rates low enough to be palatable for average earners. Countries that adopted flat taxes in Eastern Europe often faced revenue shortfalls, forcing them to raise other taxes like VAT or payroll taxes, which can disproportionately affect working people and employers.

8. Taxing the rich (progressively) is a tool to combat inequality, but rates can be too high.

“If income redistribution is considered a desirable social goal, then taxation is clearly an important means to this end—and moreover one that every country in fact utilizes,” notes the tax economist Richard M. Bird.

Addressing inequality. Progressive taxation, where higher incomes are taxed at higher rates, is a widely used tool to reduce the gap between rich and poor. This principle, rooted in notions of fairness and ability to pay, has been a feature of the U.S. income tax since its inception, initially targeting only the wealthiest Americans.

The superrich exception. In the modern U.S., the progressive pattern breaks down for the "superrich" (income over $10 million), who often pay lower effective rates than those earning less. This is largely due to preferential tax rates on capital gains (income from investments) compared to earned income (wages), a loophole that disproportionately benefits the wealthiest.

Limits to high rates. While higher progressive rates can combat inequality, setting them too high can lead to avoidance and capital flight, as seen with France's attempt at a 75% supertax. Taxpayers may resort to complex legal schemes or even move to lower-tax jurisdictions, undermining revenue collection and potentially harming the economy.

9. Corporate tax avoidance is rampant due to high rates and complex rules.

“U.S. multinational firms have established themselves as world leaders in global tax avoidance strategies,” notes Professor Edward D. Kleinbard, who teaches tax law at the University of Southern California.

High nominal rate. The U.S. corporate income tax has a high nominal rate (35%) compared to most other developed countries. This creates a strong incentive for multinational corporations to minimize their tax liability, often through complex international maneuvers.

Avoidance strategies. Companies employ sophisticated strategies to shift profits (on paper) to lower-tax jurisdictions.

• Profit Shifting: Assigning profits from sales or intellectual property to subsidiaries in low-tax countries (e.g., Caterpillar's Swiss subsidiary, Google's Bermuda/Ireland/Netherlands structure).
• Inversions: Merging with a smaller foreign company to move the legal domicile overseas, avoiding U.S. tax on foreign earnings and enabling "earnings skimming" (e.g., Burger King, Johnson Controls).
  These strategies, while often legal, are costly in terms of lawyer/consultant fees and result in billions in lost U.S. tax revenue.

Ineffective tax. Despite the high nominal rate, the effective tax rate paid by large U.S. corporations is significantly lower due to loopholes and avoidance. This makes the corporate tax less effective as a revenue source and raises questions about fairness, as companies benefit from U.S. infrastructure and markets but minimize their contribution.

10. Other countries use consumption taxes (like VAT) and behavior-modifying taxes (sugar, carbon, FTT).

“The rise of the value-added tax,” observed the economic historian Liam Ebrill, “was the most dramatic—and probably most important—development in taxation in the last half of the twentieth century.”

The ubiquitous VAT. The Value-Added Tax (VAT), or Goods and Services Tax (GST), is a consumption tax applied at each stage of production. Invented in France in the 1950s, it is now used in some 175 countries and is a major revenue source globally. Economists favor it as less distorting than income taxes and harder to evade than retail sales taxes, though it can be regressive and is sometimes criticized as an "invisible money machine."

Behavioral taxes. Beyond traditional income and sales taxes, countries use specific levies to influence behavior and raise revenue.

• Sugar Tax: Taxes on sugary drinks and junk food aim to combat obesity and fund public health initiatives, showing promising results in countries like Mexico.
• Carbon Tax: Taxes on carbon emissions or fossil fuels aim to reduce greenhouse gases and address climate change, though they can be politically challenging due to impacts on energy prices, as seen in Australia.
• Financial Transaction Tax (FTT): A small tax on financial trades (stocks, bonds, derivatives) aims to raise revenue, potentially reduce market volatility, and make the financial sector contribute to bailout costs. Despite tiny rates, it can generate significant revenue due to high trading volumes.

11. International efforts are increasing transparency and combating tax evasion.

“People hiding assets offshore should recognize,” the IRS said, that such maneuvers were likely to be futile.

Global crackdown. In response to widespread tax evasion facilitated by secret bank accounts and shell corporations in "tax havens," international efforts have intensified. Organizations like the OECD and JITSIC (Joint International Tax Shelter Information and Collaboration Network) are working to increase transparency and information sharing among tax authorities worldwide.

FATCA's impact. The U.S. Foreign Account Tax Compliance Act (FATCA) has been a major driver of this change. It requires foreign financial institutions to report U.S. account holders, backed by severe penalties for non-compliance. This has led to numerous foreign banks, including major Swiss institutions, revealing secret accounts and paying billions in fines, prompting other countries to enact similar laws.

The Panama Papers. The massive leak of documents from the Mossack Fonseca law firm in Panama in 2016 exposed the scale of offshore wealth hiding and the use of shell corporations. This journalistic scoop highlighted the need for greater transparency and spurred investigations and political fallout globally, putting pressure on remaining secrecy jurisdictions.

12. Simplification is essential, and other countries show how easy filing can be.

As a result, paying income tax is a totally automatic process for about 80% of Japanese households, requiring no more work than reading a postcard once a year.

Complexity's cost. The extreme complexity of the U.S. tax code imposes enormous compliance costs on taxpayers and undermines trust in the system. The IRS Taxpayer Advocate consistently identifies complexity as the number one problem, arguing it makes compliance difficult, requires costly professional help, obscures understanding, and facilitates avoidance.

Government-prepared returns. Many other developed countries have dramatically simplified filing by having the tax agency prepare returns using information reported by employers, banks, and other payers.

• Japan: Uses "precision withholding" and sends postcards; 80% of taxpayers do nothing.
• U.K.: Uses "Pay as You Earn" and pre-fills returns; only 1 in 5 taxpayers need to file.
• Netherlands: Pre-fills returns, taking minutes for many.
  This "pre-filled forms" approach shifts the burden from taxpayer to tax collector, reduces errors, and is popular where implemented.

Political obstacles. Despite potential savings of billions of hours and dollars, implementing pre-filled forms in the U.S. faces opposition, notably from the tax preparation industry (like Intuit/TurboTax) that profits from complexity. True simplification requires a commitment to BBLR principles and overcoming entrenched interests that benefit from the current convoluted system.

Last updated: June 11, 2025