the american tax system
— April 12, 2012 —
The information in this publication is general educational
material and must not be considered to be legal or tax
advice. Despite its length, this publication does not cover
all applicable issues, and there may be other issues that
are not analyzed in this publication. You may not rely on
this publication to avoid tax penalties or liabilities, and
you may not use this publication for any purpose other
than the consideration of the issues discussed herein. For
more information about your own tax or legal situation,
please consult your own tax or legal advisors.
WHAT’S IN SIDE
FEDERAL DEFICIT REDUCTION
01 AN INTRO TO REVENUE AND TAXES
A LOOk AT TAxEs
02 cOmmON TAX TERmS
A LOOk AT TAxEs
04 TAX EXpENDITURES
A CLOsER LOOk
06 FEDERAl cORpORATE INcOmE TAXES
A CLOsER LOOk
08 FEDERAl INDIVIDUAl INcOmE TAXES
ALTERNATIvE TAx TERMs
09 WhAT’S BEINg DIScUSSED IN WAShINgTON
ARE TAxEs ThE TICkET?
11 cAN WE TAX OUR WAY OUT?
15 EXpIRINg pOlIcIES BY YEAR END
kNOwLEDgE Is pOwER
17 SORTINg ThROUgh ThE RhETORIc
FEDERAL DEFICIT REDUCTION
AN INTRO TO REVENUE AND TAXES
As Americans rush to file their 2011 income tax returns with April 17 quickly
approaching, the debate continues in Washington over congressional
budgeting and deficit reduction. As Washington continues to figure out how
to use your tax money and whether or novt to require more of it, reduce
spending, or both, we thought it would be helpful to educate Americans on
the messy tax system that politicians in Washington have created.
Throughout the deficit reduction debate in Washington, some politicians
have championed the need to reform the federal tax code. While there are
disagreements on the specifics of how to reform the tax code, most scholars
agree that a simple, equitable, and efficient tax code has great potential to
both lower the federal deficit and promote economic growth.
A LOOk AT TAxEs
cOmmON TAX TERmS
many Americans understand basic tax terms because, each year, they spend
hours dealing with the tax code when they file their taxes by mid-April. But below,
we aim to give the reader a deeper understanding of common tax terms.
whAT ARE DEDUCTIONs?
In general, deductions are subtracted from your taxable income. In other
words, if you qualify for a deduction of $3,000, this does not mean your
tax bill is reduced by $3,000; it means that your taxable income is reduced
by $3,000. For an individual in a 35% tax bracket, each $100 deduction
means he or she would pay $35 less in taxes1.
Taxpayers can take deductions in one of two ways:
The standard deduction, which is $5,8002 for a single taxpayer and
$11,600 for a married couple filing jointly. The taxpayer gets this
automatically with no need for itemization.
The itemized deduction, which is generally used if you have deductions
over the standard deduction. in this case, you generally have to itemize
each deduction. Examples of itemized deductions include the mortgage
interest deduction and the charitable contribution deduction.3
whAT ARE ADjUsTMENTs TO INCOME?
Adjustments to income are deductions that all taxpayers can take, in addition
to the standard deductions. They include such things as moving expenses,
regardless if you used a standard or itemized deduction4.
whAT ARE pERsONAL ExEMpTIONs?
personal exemptions “are allowed for the taxpayer, his or her spouse (if
married and filing a joint return), and each dependent5.” A dependent can
be a qualifying child or relative6. In 2011, the value of each personal and
dependent exemption, for most taxpayers, is $3,7007. Similar to a deduction,
each personal exemption reduces your taxable income.
whAT ARE ExCLUsIONs?
Exclusions are something that are not included in taxable income “because the
tax code explicitly exempts [them] from tax.” An example of an exclusion is
the interest earned on state and local bonds.8
whAT ARE CREDITs?
generally, tax credits are subtracted directly against the total taxes you owe.
Unlike a deduction, which is subtracted from your taxable income, a credit is
subtracted against your tax bill on a dollar-for-dollar basis, whether or not you
itemize your deductions.9
generally, there are two types of credits:
a refundable credit, which can exceed the amount of taxes you owe.
in other words, it is a direct payment from the U.S. government10. an
example of a refundable credit was the first-time homebuyers credit that
was created in the 2009 stimulus.
a non-refundable credit, which can only be used up to the extent that
you owe taxes11. an example of a non-refundable tax credit is child-
A LOOk AT TAxEs
The ideas behind all of the concepts explained above are key because,
generally speaking, they fall into tax expenditures, which are considered to be
forms of government spending accomplished through the tax code instead of
through direct government spending12.
although there are various estimates on what qualifies as a tax
expenditure, the non-partisan Joint committee on Taxation determines a list
of tax expenditures.
To do this, they determine if the provision is part of the “normal income
tax law.” if it is not part of the “normal income tax law,” the tax provision
is considered to be a special provision and thus is a tax expenditure.13
Treasury also identifies tax expenditures. in 2011, they estimated tax
expenditures totaled $1.3 trillion14.
“Tax expenditures, in many ways, are similar to entitlement spending” such as
medicare, medicaid, and Social Security because they “…often remain in
the tax code until changed or eliminated by congressional action15.” In fact,
if tax expenditures are included in total government expenditures in fiscal year
2010, they made up nearly 24 percent of total expenditures16. In that same
year, mandatory spending such as medicare, medicaid, and Social Security
made up more than 42 percent of total expenditures17.
For individual income taxes, one of the biggest tax expenditures is the mortgage
interest deduction, which is estimated to cost nearly $100 billion a year18.
The former director of the non-partisan congressional Budget office,
Douglas holtz-Eakin, claimed the mortgage interest deduction is the “last
he also claimed “owner-occupied housing in the United States may grow at
the expense of more productive investments elsewhere in the economy.” 19
For corporate taxes, one of the biggest tax expenditures is accelerated (i.e.,
generally, businesses are able to deduct capital costs, such as a new piece
of equipment, over the useful life of the asset since it is a business expense.
Bonus depreciation allows businesses to recover these costs in a shorter
period of time through larger deductions.20
According to the non-partisan congressional Research Service, tax expenditures
such as the mortgage interest deduction, “…are seen as targets to be reduced
or eliminated…” should the current congress decide to enact comprehensive
whAT ARE “LOOphOLEs?”
What one person may see as a benefit, another person may see as a
loophole. “Special deductions, exclusions, and exemptions (sometimes
characterized as ‘loopholes’) have been in the tax code since the passage of
the progressive income tax in 191322.”
whAT ARE sOME ExAMpLEs OF bIzARRE DEDUCTIONs ThAT
TAxpAyERs ATTEMpTED TO CLAIM?
Some bizarre deductions:23
consulting fee: Business owner paid arsonist $10,000 to torch his
furniture store and attempted to write it off.
Marijuana: a drug dealer worked with his accountant to list his crop as a
Family wedding: one parent tried to deduct a daughter’s wedding
expenses as business entertainment.
A CLOsER LOOk
FEDERAl cORpORATE INcOmE TAXES
In the last fiscal year, the federal corporate income tax comprised nearly eight
percent of the federal government’s total revenue24. According to the mercatus
center, “like individual income tax rates, corporate income tax rates are
progressive, increasing with higher levels of income.” When a person hears the
discussion of the corporate tax rate, it is usually in context of the highest rate. For
corporations that earn profits greater than $18,333,333, they are taxed at the
top rate of 35 percent.25 Recently, the United States was named for having the
highest corporate income taxes in the world26.
But due to the complexity of the tax code, credits, and deductions, among other
reasons, many companies do not pay the top tax rate.
The effective tax rate, which accounts for all “deductions, credits,
depreciation, and preference in the tax code27,” is estimated to be
between 22 and 27 percent28.
no matter if you are looking at the actual rate or the effective rate of
taxes, “the United States has one of the highest corporate tax rates in the
Not only does the U.S. tax system tax corporations at an extremely high rate
relative to the rest of the world, but it also taxes certain profits “…on all income
regardless of whether they earn that income domestically or internationally.”
not all overseas profits are treated this way because certain overseas
profits are not taxed unless the corporation transfers those foreign earnings
back to the United States.
it is true that U.S. corporations may take a tax credit for certain taxes paid
to foreign governments so the same income is not taxed twice in theory.
however, the Mercatus center reports that “…complex rules limit U.S.
corporations from taking full credit for foreign taxes.”
For a developed country like the United States, it is unusual that the U.S.
does not use a territorial taxation system where corporate income is taxed
in the country where the income is earned.30
The mercatus center goes on to explain that “[i]f the foreign tax rate is less
than 35 percent, as it is in most developed countries, U.S. firms have a tax
incentive to keep their profits overseas31.” Further, “the high corporate income
tax rate distorts firms’ incentive structures and investment behaviors. It sometimes
becomes more ‘profitable’ for companies to invest in lobbyists who can expand
tax preferences than to use those resources to expand business output.32”
According to a scholar the Urban Institute, the time is ripe for corporate tax
reform: “Add in rising concern about America’s international competitiveness
and slow economic recovery, and you have a recipe for a bipartisan push to
cut corporate tax rates33.”
A CLOsER LOOk
FEDERAl INDIVIDUAl INcOmE TAXES
In the last fiscal year, federal individual income taxes comprised nearly 47
percent of the federal government’s total revenue34. like corporate income tax
rates, individual income tax rates are progressive, meaning the rates increase
with higher levels of income. For a person that earns an income greater than
$379,150, he or she is taxed at the top rate of 35 percent35.
But due to the complexity of the tax code, loopholes, and other reasons, virtually
no one pays the top income tax rate of 35 percent.
The non-partisan congressional Budget office last studied the effective
tax rate, which accounts for all “deductions, credits, depreciation, and
preference in the tax code36,” in 2007. For the highest income earners (the
top five percent), they found the effective individual income tax rate to be
17.6 percent in 2005.37
This same report documented that the lowest income category
(i.e., the lowest quintile) paid an effective tax rate of -6.2 percent in 200538.
ALTERNATIvE TAx TERMs
WhAT’S BEINg DIScUSSED IN WAShINgTON
Washington is also buzzing about alternative tax systems. Below is a
breakdown on the terms for other tax ideas.
whAT Is ThE vALUE-ADDED TAx?
generally speaking, it is a consumption tax that taxes “the value that a
firm adds to a product at each stage of production.” This tax is collected
during every stage of production. It is similar to a national sales tax but
is broader in its scope since it applies to every level of production — not
just the retail level when a sale is made.39
whAT Is A FLAT TAx?
Essentially, it is a modified value-added tax; however, it takes wages and
pensions and taxes them separately relative to the other parts that make
up a value-added tax40.
whAT Is A FAIR TAx?
generally speaking, it replaces the individual income tax, corporate
income tax, payroll taxes, the self-employment tax, and the estate/gift
taxes and replaces it with a national sales tax.41
whAT Is ThE “bUFFETT RULE” TAx?
Recently, president Obama has called for fairness in the tax code. The
president says one way to do this is to enact the so-called “Buffett Rule.”
Under this proposal, wealthy Americans would pay a minimum tax rate
of 30 percent. One reason some wealthy Americans can pay a lower
tax rate is because investment income is taxed at a lower tax rate than
According to analysis, however, the proposed tax would do almost
nothing in terms of deficit reduction. congress’ independent tax analysis
arm, the Joint committee on Taxation, determined this proposed tax would
raise just $47 billion over the next 10 years43. When looking at the non-
partisan congressional Budget Office’s projected debt over the next decade
of $21.665 trillion, $47 billion represents 0.2 percent in deficit reduction44.
According to these numbers, the facts show that this proposed tax would
do almost nothing in terms of deficit reduction.
ARE TAxEs ThE TICkET?
cAN WE TAX OUR WAY OUT?
In 2008, the independent congressional Budget Office was asked to
determine what the tax rates would have to be if they used “higher income tax
rates alone to finance the increases in spending projected.”45 This was the last
time the cBO did such an analysis.
here is what the cBO determined at the time:
In order to keep up with projected spending, taxes would have to increase46:
corporate: current top rate 35%; rate increase to 88%
highest income tax rate: current rate 35%; rate increase to 88%
near-the-middle income tax rate: current rate 25%; rate increase to 63%
Lowest income tax rate: current rate 10%; rate increase to 25%
spENDINg bREAkDOwN OCT 1, 2010 – sEp 30, 2011
(ThE LAsT FIsCAL yEAR)
Where your tax dollars (and borrowed money) are spent:47
(numbers may not add due to rounding; percents are equivalent to cents)
It’s spending that’s on autopilot because it is required by law and is not subject
to the annual congressional appropriations process.
Social Security: $725 (20% of spending)
Medicare: $480 billion (13% of spending)
income Security: $526 billion (15% of spending)
Medicaid & other health: $310 billion (9% of spending)
It’s spending for programs and agencies that occurs through yearly
congressional action (called appropriations acts).
non-Defense: $648 billion (18% of spending)
This includes international affairs, science, space, technology, energy,
natural resources, transportation education housing assistance, etc.
Defense: $699 billion (19% of spending)
ThE sOURCEs OF REvENUE49
individual income Taxes: $1,091 billion (47%)
corporate income Taxes: $181 billion (8%)
Social insurance & retirement receipts: $819 billion (36%)
Excise Taxes: $72 billion (3%)
other: $140 billion (6%)
EXpIRINg pOlIcIES BY YEAR END
At the end of 2012, many tax policies are set to expire. (And congress has yet
to address several tax policies that expired at the end of last year, as we outline
below.) here, we take a look at several of them.
pAyROLL TAx hOLIDAy
In December 2010, congress created a temporary measure that reduced what
employees pay in Social Security taxes. In February 2012, this provision was
extended through the end of 201250. currently, employees pay two percent less
in Social Security payroll taxes than what is traditionally paid. If this provision
expiries, it “…means low-income workers will pay several hundred dollars more
than they’re paying now, while high-income workers will pay roughly $2,340
more51.” Since this “temporary tax holiday” has been extended more than
once, it could be extended again.
many tax code provisions expired at the end of 2011. Some of these provisions
may not be renewed, but it’s likely that many will be, including the research and
development tax credit. These expiring provisions generally “…fall into a group
of tax deductions, credits and provisions — now known as ‘extenders’ — which
congress has repeatedly renewed, but never makes permanent, simply because
it doesn’t want to acknowledge their true costs.”52 It is likely that congress
retroactively extends some of these tax extenders for 2011, something congress
did the last time tax extenders were addressed by congress.
ALTERNATIvE MINIMUM TAx (AMT)
In 1969, congress created the AmT. To understand the AmT, it’s helpful to view
it as an entirely separate federal tax structure. generally speaking, tax rates and
deductions under the AmT are not as generous as those under the regular income
tax system.53 In other words, it is not good news if a taxpayer falls under the AmT.
The stated goal of the AmT was to make sure the wealthiest Americans owed
some income taxes. In 1967, the Treasury secretary reported 155 people with
incomes more than $200,000 owed no income tax because they were able to
use tax code deductions and credits to bring their tax liability to zero.54
The AmT isn’t indexed for inflation, which means more and more middle class
families now fall under the AmT55. To limit the impact of the AmT, congress
traditionally passes a “patch.” According to the Tax Foundation, “’patching’ means
raising the income level automatically exempt from the AmT, usually for one year
or two.”56 For 2011, the AmT exemption for a single person is $48,45057.
like tax extenders, the AmT is not permanently addressed because congress
simply doesn’t want to acknowledge its true cost. currently, there is no patch for
the AmT for 2012, so “…all taxpayers can do is wait for congress to approve
It should be noted that congress could wait to retroactively address the tax
extenders and AmT issues until next year. They’ve done it before. however,
“such delays are a pain for a lot of taxpayers. For example, for most of 2010,
families subject to, or possibly subject to AmT, were unsure of how much in
estimated taxes to pay. meanwhile, because the Internal Revenue Service
computers had to be reprogrammed for late changes, 2010 tax refunds were
delayed for 6.6 million taxpayers....” Additionally, retroactively changing the
tax code caused some public companies to restate their earnings.59 Some
believe that having to retroactively change the tax code creates uncertainty.
INDIvIDUAL INCOME TAx RATEs
In December 2010, president Obama extended the income tax cuts of 2001
and 2003 through the end of 2012. prior to the 2001 law, the income tax
rates were as follows (with the actual rate depending on what the taxpayer
earns):15%, 28%, 31%, 36%, and 39.6%. Through 2012, the rates are as
follows:10%, 25%, 28%, 33%, and 35%. As is stands now, these tax rates
will reset to the rates before the 2001 law passed at the start of next year.60
however, congress is likely to address this issue in some capacity before the
end of the year.
kNOwLEDgE Is pOwER
SORTINg ThROUgh ThE RhETORIc
We at Bankrupting America believe that considering the fact that this country
ran a deficit of $1.3 trillion last year, it’s clear Washington must start with cutting
spending, not with raising taxes.
As congress discusses ways to cut the federal deficit, many options for
comprehensive tax reform could be discussed and implemented. Bankrupting
America believes that while tax reform is key, we shouldn’t be giving Washington
another dollar through higher tax rates unless Washington proves it can be wise
with the money we’ve already given them.
During this time, a strong knowledge of current tax policy and reforms may help
Americans sort through rhetoric and hold elected officials accountable for any tax
policy decisions they make.
1 cRS: Federal Income Tax Terms: An Explanation. June 20, 2006. p. 2.
2 TurboTax: Tax Tips After January 1, 2012. http://turbotax.intuit.com/tax-tools/tax-tips/Tax-planning-and-
3 cRS: Federal Income Tax Terms: An Explanation. June 20, 2006. p. 2.
4 cRS: Federal Income Tax Terms: An Explanation. June 20, 2006. p. 2.
5 cRS: Federal Income Tax Terms: An Explanation. June 20, 2006. p. 3.
6 IRS: Dependents & Exemptions. Accessed October 31, 2011. http://www.irs.gov/faqs/
7 IRS: press Release, In 2011, many Tax Benefits Increase Slightly Due to Inflation Adjustments. December 23,
8 cRS: Federal Income Tax Terms: An Explanation. June 20, 2006. p. 1.
9 cRS: Federal Income Tax Terms: An Explanation. June 20, 2006. p. 5.
10 cRS: Federal Income Tax Terms: An Explanation. June 20, 2006. p. 5.
11 cRS: Federal Income Tax Terms: An Explanation. June 20, 2006. p. 5.
12 cRS: Tax Expenditures and the Federal Budget. June 1, 2011. p. 6. http://www.fas.org/sgp/crs/misc/
13 cRS: Tax Expenditures and the Federal Budget. June 1, 2011. p. 6. http://www.fas.org/sgp/crs/misc/
14 Urban Institute: how large are Tax Expenditures? march 28, 2011. http://www.urban.org/
15 cRS: Tax Expenditures and the Federal Budget. June 1, 2011. p. 2. http://www.fas.org/sgp/crs/misc/
16 cRS: Tax Expenditures and the Federal Budget. June 1, 2011. p. 5. http://www.fas.org/sgp/crs/misc/
17 cRS: Tax Expenditures and the Federal Budget. June 1, 2011. p. 5. http://www.fas.org/sgp/crs/misc/
18 Bloomberg: A Taxing Debate, The mortgage-Interest Deduction. October 18, 2011. http://www.
19 Jason Fichtner and Jacob Feldman, the mercatus center. Working paper: lessons from the 1986 Tax Reform
Act. April 2011. p. 4. http://mercatus.org/sites/default/files/publication/Fichtner.86Tax.4.12.11_0.pdf.
20 cRS: Reducing the Budget Deficit, Tax policy Options. April 26, 2011. p. 16. http://assets.opencrs.com/
21 cRS: Tax Reform, An Overview of proposals in the 112th congress. April 20, 2011. p. 2. http://www.
22 cRS: Tax Expenditures and the Federal Budget. June 1, 2011. pp. 5 – 6. http://www.fas.org/sgp/crs/
23 Turbo Tax: 8 of the craziest Illegal Tax Deductions Ever claimed. Accessed march 19, 2012. http://
24 OmB. president’s FY13 Budget historical Table 2.1. February 2012. http://www.whitehouse.gov/omb/
25 mercatus: Why the United States Needs to Restructure the corporate Income Tax. November 2011. pp. 2.
26 Bloomberg News: Japan’s Rate Drop puts U.S. at Top of corporate Tax Rankings. April 2, 2012. http://
27 mercatus: Why the United States Needs to Restructure the corporate Income Tax. November 2011. pp. 2.
28 congressional Research Service. An Analysis of the “Buffett Rule.” October 7, 2011. p. 5. http://
29 mercatus: Why the United States Needs to Restructure the corporate Income Tax. November 2011. pp. 3.
30 mercatus: Why the United States Needs to Restructure the corporate Income Tax. November 2011. pp. 7.
31 mercatus: Why the United States Needs to Restructure the corporate Income Tax. November 2011. pp. 7.
32 mercatus: Why the United States Needs to Restructure the corporate Income Tax. November 2011. pp. 9.
33 Tax Reform: The Wheels Are Beginning to Turn. Urban Institute. February 15, 2011. http://www.urban.
34 OmB. president’s FY13 Budget historical Table 2.1. February 2012.
35 Tax Foundation. Federal Individual Income Tax Rates history. Accessed April 4, 2012.
36 mercatus: Why the United States Needs to Restructure the corporate Income Tax. November 2011. pp. 2.
37 congressional Budget Office. historical Effective Tax Rates: 1979 to 2005. December 2007. http://
38 congressional Budget Office. historical Effective Tax Rates: 1979 to 2005. December 2007. http://
39 cRS: Tax Reform, An Overview of proposals in the 112th congress. April 20, 2011. p. 3. http://www.
40 cRS: Tax Reform, An Overview of proposals in the 112th congress. April 20, 2011. p. 4. http://www.
41 cRS: Tax Reform, An Overview of proposals in the 112th congress. April 20, 2011. p. 1-2. http://www.
42 Associated press: Obama presses congress to pass ‘Buffett Rule’ Tax Increase on millionaires. march 31,
43 Associated press: Obama presses congress to pass ‘Buffett Rule’ Tax Increase on millionaires. march 31,
44 calculated by dividing $47 billion (Joint Tax score of “Buffett Rule”) by total projected debt ($21.665
trillion) Fiscal Years 2013-2022. Source: cBO. Budget and Economic Outlook. January 2012. Table 1.4.
45 congressional Budget Office. letter to Budget committee chairman paul Ryan. may 19, 2008. p. 8.
46 congressional Budget Office. letter to Budget committee chairman paul Ryan. may 19, 2008. p. 8.
47 Numbers calculated by dividing expenditure by total outlays. OmB historical Table 8.5. Accessed April 4,
48 Numbers calculated by dividing expenditure by total outlays. OmB historical Table 8.7. Accessed April
4, 2012. http://www.whitehouse.gov/omb/budget/historicals
49 OmB. president’s FY13 Budget historical Table 2.1. February 2012. http://www.whitehouse.gov/omb/
50 Reuters: congress Extends payroll Tax cut, Sends to Obama. February 17, 2012. http://www.reuters.
51 cNN money: payroll tax cut. December 2, 2011.
52 Forbes: Dozens of tax breaks set to expire on Dec. 31. December 2, 2011.
53 Smart money: The Alternative minimum Tax. February 3, 2012.
54 Tax Foundation: Backgrounder on the individual Alternative minimum Tax. Accessed April 4, 2012.
55 Tax Foundation: Backgrounder on the individual Alternative minimum Tax. Accessed April 4, 2012.
56 Tax Foundation: how do the Bush Tax cuts interact with the Alternative minimum Tax? Accessed April 4,
57 cQ.com. Fact Sheet 111.38. Subscription required.
58 cNBc: AmT to hit Record Number of Taxpayers This Year. April 2, 2012. http://www.cnbc.com/
59 Forbes: Dozens of tax breaks set to expire on Dec. 31. December 2, 2011.
60 cQ.com. Fact Sheet 111-38. Subscription required.
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[published April 12, 2012]