Tax Code Bucket List: What Needs to Go

Our tax code has been called a lot of things: long, complex, archaic. But a game of cops and robbers? That might be a new one.

“It’s hard to run an income tax properly because you have to know how assets change in value,” says David Shaviro, Wayne Perry professor of taxation at NYU Law. “In theory, you should be taxed when assets go up and receive deductions when they go down. But people come up with ways of getting around the rules. It’s a cops and robbers game.”

The U.S. tax code is always under extreme scrutiny, especially coming on the heels of President Obama’s budget proposal for 2014, which calls for tax revenue increases of $1 trillion over the next decade.

Personal finance expert Jordan Goodman says the code has become so controversial because lobbyists with the loudest voices often receive the most favorable breaks when Congress makes changes the system, which complicates it even further.

“The rules are very complex,” he says. “A lot of money is spent on avoiding the rules and getting around them. The end result is that people with lots of money can do well by avoiding the rules and taking advantage of them and the person with less power pays more.”

Here are a few of the items these tax experts say they’d like to see reformed or removed from the tax code as it currently stands:

Should Go: Secondary earner bias. Shaviro says married couples are discouraged from going to work because the childcare tax breaks are not high enough. “Suppose the second person earns $30,000 for going to work, but pays $20,000 for child care—you are only up by $10,000. It’s a prohibitive tax for a lot of people. The system strongly discourages having that second person go to work,” he says.

Needs Reform: Health-care benefit taxes. Employees are not taxed on the benefits they receive from their employers and Goodman says this is a mistake. This part of the tax code came about after WWII, when there were wage and price controls, he says, and companies had to offer benefits to workers because they couldn’t up their salaries.

“In the tax code, those benefits were free,” he says. “Now it’s limited at up to $50,000 [in benefits]. For the company it’s a deduction, but it should also be taxable to the employee.”

Should Go: Home mortgage interest deduction. People in today’s market own “too much home” instead of too little, Shaviro argues. “It’s a tricky proposition, but I say it needs to go,” he says. “It creates a tax price that favors home ownership.”

Goodman says the deduction should stay, but be more limited. As it stands currently, those with multimillion dollar homes can receive deductions on interest of up to $1 million on their first mortgage, and up to $100,000 for their second mortgages.

“It’s a reverse Robin hood tax,” he says. “The bigger the house you have, the more of a tax deduction you get. It would destroy the housing market entirely to take it away, but let’s cap it at $500,000 instead of $1 million. This is subsidizing rich people getting a big house with a big mortgage.”

Should Go: Carried interest deduction for hedge funds. Capital gains are currently taxed at 15%, compared to regular income tax which can hit 39.6% for top earners, Goodman says. Hedge funds earn their profits by manipulating this income as capital gains so they can pay that lower rate. “They can afford to pay more,” he says. “The hedge fund community would go bonkers if this changed, because it’s big money.”

Should Go: Basis step-up at death. Currently if a taxpayer holds assets until he or she dies, the tax on those assets disappears after death. “Steve Jobs would only have been taxed on stock if he sold it when he was alive,” Shaviro says. “Your kids can get it, and it’s never taxed, because the tax is disappeared.”

As it stands now any assets can be bought and sold freely without penalty after the holder dies. Shaviro says the fact that taxpayers are taxed for selling these assets distorts behavior, and creates “lock-in.”

Needs Reform: Taxing multinationals on foreign income. Shaviro says multinationals are given the opportunity to pretend they are earning money in tax savings, but are unable to access profits without paying taxes. “They try to get at the money without being deemed by the tax system,” he says.

Goodman says instead of penalizing multinationals for accessing the cash they have stored overseas, the tax code should encourage then to bring that money to the U.S. and invest it.

Needs to Go: Corporate debt buying. Our current tax code favors companies who are loading themselves up with debt instead of equity, Shaviro says. “This gives companies the incentive to have debt,” he says. “You deduct interest that you pay to shareholders but not the interest you pay on dividends.”

Needs to Go: Gambling losses. When taxpayers travel to Las Vegas or Atlantic City and lose their cash on bets, Uncle Sam gives them a tax break, which Goodman says is counterproductive. “You can deduct gambling losses, and this is offset with winnings. But if people want to gamble, why should taxpayers be subsidizing this? I think it’s good to tax winnings but I don’t think losing should be deductible.”

Should Go: Renewable energy tax credits. The credits the government offers for renewable energy items such as buying a hybrid car or installing solar panels is good-intentioned, not necessary, says Goodman . “The actual results in the real world have been relatively minimal,” he says. “The solar industry is in a depression now, but if the industry is ‘so big’ the government shouldn’t have to subsidize it. If it’s that good, let people pay for it on their own.”