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Terminating the Tax Code
Will Hurt Taxpayers

Clint's Window
by Clint Stretch, Director of Tax Policy, Deloitte & Touche LLP

Wednesday, June 17, 1998

What would replace it? Consumers and business need to know.

See our archive
for past issues of
Clint's Window.

Terminating the tax code without a widely acceptable plan to replace it will hurt ordinary taxpayers by making personal financial decisions and business planning impossible. The House of Representatives passed a bill to terminate the code June 17.

A vote by the House to "sunset" the Internal Revenue Code can be considered pure politics and ordinary taxpayers will pay the bill. Every important personal financial decision and many business decisions will be much more difficult, since taxpayers will not be able to rely on current tax law, but no new system exists to offer alternative guidance.

The current income tax is too complex, but most taxpayers rely on the tax code every day. Americans routinely buy homes, invest in individual retirement accounts, and allocate funds in their investment portfolios without consulting a tax professional. They buy assets for their businesses and divide their estates between children, grandchildren, and charities. They do all this by taking taxes into account, even if they do not understand all the details.

Taxpayers might be affected by the termination of the tax code in at least five ways:
  1. The choice between renting and owning will be more difficult.

    Will mortgage interest and real estate taxes still be deductible? Will rents go up or down with a new tax law? If investment income will be free of tax, should homebuyers minimize any down payment?

  2. Workers will be unable to make informed decisions about retirement savings options.

    Is a regular IRA or a Roth IRA the best choice? Deciding is hard enough under existing law. It’s impossible if future tax rates are unpredictable. Will income from IRAs even be taxed under the new system? Do non-qualified plans such as stock-option programs still make sense? Will employers reduce benefits in response to a new tax system?

  3. Deciding where to invest taxable savings for the long-term will be difficult.

    How will changing tax laws affect the value of current investments? Will tax-favored investments, such as life insurance, annuity contracts, and tax-exempt bonds, become less attractive? How will rental real estate be taxed? What will happen to unused passive losses on real estate?

    If the tax system changes dramatically, will today’s smart investment become tomorrow’s loser? Will investments in tax-favored industries be damaged by sunsetting the code? Will new winners appear?

  4. Business owners will delay investment in capital plants and equipment.

    What depreciation deductions will be allowed for a new capital investment? Will the new system allow some depreciation on old investments to continue? Under the new system, will all of an investment be deducted in the year it is made (i.e., expensed)? Or, will the new tax system allow no deductions for investments (for example, a sales tax)?

  5. Older individuals will be unable to make wise estate planning choices.

    How much should be left in trust and for whom? Should substantial assets be given to charities? Are sophisticated planning techniques worth the investment, if they may become obsolete? Are lifetime gifts still necessary to minimize tax?

The Costs of Reform without the Benefits

While sunsetting the code is being offered as a path to fundamental tax reform, voters aren’t buying the flat tax and voters aren’t buying a sales tax. Now, politicians want them to buy a sunset and a happily-ever-after promise.

The idea of replacing the current tax system with a completely new one is promoted as a vehicle for greater economic growth. How much growth, if any, is open to question, but the substantial costs that such a shift would impose are clear. Sunsetting the tax code will impose transition costs and create uncertainties without any of the hoped for economic benefits that might come from actually adopting a new tax system.

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