Outrageous Facts About the Income Tax

by Chris Edwards, director of fiscal policy studies at the Cato Institute.

As you struggle to prepare your taxes this year, you may take some comfort in knowing that your headache is being felt across the country. The following odd and outrageous facts show how widespread income tax problems are:

The U.S. "tax army" is bigger than the U.S. army in Iraq.
Income taxes are so complex that there are up to 1.2 million paid tax preparers in the country -- six times more than the number of troops in Iraq. The tax army includes legions of accountants, lawyers, and computer experts -- some of the best minds in the country. Unfortunately, their brainpower is adding little to the nation's standard of living.
A tax form for every special interest.
As the income tax grows more complex, the number of IRS tax forms has jumped from 402 in 1990 to 526 by 2002. Congress hands the accountants business on a silver platter when they create special interest tax forms such as "8845-Indian Employment Credit" and "8834-Qualified Electric Vehicle Credit." When Congress penalizes an activity, we get tax forms such as "6197-Gas Guzzler Tax." It's time to end the micromanaging and adopt a simple flat-rate tax. Until then, Congress needs to supplement "6478-Credit for Alcohol Used as Fuel" with form "XXX-Credit for Alcohol Used for Drinking."
Double-tax on dividends: 60 years and still not fixed.
Sixty years ago, a Treasury report noted that "double taxation of corporate profits is the principal problem raised in connection with the corporation income tax." In the 1930s, a Treasury report argued that the tax disincentive to pay dividends caused corporate management problems. Recent scandals proved them right. Congress should bite the bullet and reform dividend taxes now -- before the next round of corporate scandals begins.
Congress promotes discrimination through the tax code.
The front of the Supreme Court building boldly declares "equal justice under law," yet the income tax has hundreds of discriminatory provisions. For example, homeowners are treated more favorably than renters since they can deduct mortgage interest and other itemized deductions. Consider that a higher-income homeowner can effectively deduct car loan interest by shifting around his finances but a lower-income apartment dweller cannot. Americans would not stand for such discrimination on other taxes -- imagine if each shopper at Wal-Mart was assigned a different sales tax rate!
Congress on tax complexity: Who us?
Congress frequently holds hearings on tax simplification so members can denounce the tax code's complexity. Each time, congressional experts and outside think tanks provide useful simplification ideas. Then when the TV cameras are turned off, Congress promptly ignores them and votes for more special interest breaks. The result: The number of pages in the tax code and regulations doubled from 26,300 in 1984 to 54,846 by 2003, according to tax publisher CCH.
AMT designed to catch 155 taxpayers will soon catch 37 million.
The alternative minimum tax is an unneeded parallel tax system alongside the ordinary income tax. It began life in 1969 after Congress was shocked (shocked!) to learn that 155 wealthy individuals were not paying tax because they used too many of the deductions that Congress had provided them. The AMT has been a complex nuisance ever since. But this dumb idea aimed at the rich is set to explode on the middle-class as the number of AMT taxpayers skyrockets from 3 million today to 36 million by 2010.
Voluntarism works for the U.S. military, not the income tax.
For years, officials have hailed the income tax as a voluntary system. The Treasury calls it "our voluntary tax system." The IRS says that it pursues "enforcement programs to promote voluntary compliance" and establishes "strategies to maximize voluntary tax law compliance by emphasizing customer satisfaction." But with 32 million IRS penalties assessed each year and about $10,000 in income taxes imposed on each taxpaying household, the tax isn't voluntary and these customers aren't satisfied.
Congress can't figure out how to measure "income."
Although the income tax is 90 years old, Congress still can't figure out how to measure "income." Some income such as municipal bond interest is not taxed, but other income such as dividends is taxed twice. The income tax treatment of savings is particularly incoherent and unstable. For example, there have been 25 major changes in the capital gains tax since 1922. The solution is to replace the income tax with a low-rate tax that exempts savings.
Family saving shouldn't require an advanced math degree.
Shouldn't saving for education, retirement, and other items be as simple as putting money in the bank? Instead, Congress has manufactured hundreds of special savings rules, such as for 401(k)s, Keoghs, deductible IRAs, nondeductible IRAs, education IRAs, Roth IRAs, traditional pension plans, annuities, SIMPLEs, SEPs, MSAs, and others. The IRS guide to IRAs alone is 105 pages long! President Bush's initiative to consolidate the savings plans and create a universal IRA would be a good step to bring some sanity to this mess.
Income taxes: A bad idea that got worse.
The income tax is not an example of a good idea gone bad. It was bad from the beginning, and it just keeps getting worse. The income tax distorts financial planning and business investment, and it encourages tax avoidance and evasion. Because the income tax is built on an unworkable base of "income," the law is continually changing. Let's simplify Americans' finances and disband the tax army by pursuing fundamental tax reform. In 1913 it were 400 Total Pages of Federal Tax Rules. Today it is 54,846 Pages!

Do you think you pay too much tax?

If so, bad news and good news for you. The bad news is, you're right. You do pay too much tax. The good news is, you don't have to -- if you know how to take advantage of perfectly-legal, audit-proof strategies to slash that bill.

In 1999, 2,525 Americans reported over $200,000 in income and paid nothing in tax. Think of them as the "Navy SEALs" of Form 1040. These taxpayers pray we never see a flat tax - because, if we do, they'll actually have to pay. How do they do it?

You probably look at the tax code and see 3,000 pages of gibberish. And who can blame you? Former President Jimmy Carter called it "a disgrace to the human race."

Look at the tax code. 3,000 pages of opportunity. Opportunity to earn nontaxable income. Opportunity to write off thousands in new deductions. Opportunity to build your financial future without IRS interference.

The only problem is finding those opportunities. You can spend endless hours digging through the law. Reading the Internal Revenue Code. Digesting Treasury Regulations. Reviewing Tax Court cases. Scanning Revenue Rulings, Letter Rulings, and Technical Advice Memoranda.

But that takes time. And you've got a business to run. Investments to manage. A family to raise.

Finally, Top Ten Craziest Sales Tax Laws:

10. In Minnesota, non-edible cake decorations are taxable, but edible cake decorations are exempt.

9. In California, chewing gum is considered candy, or a "nonfood" product, and taxed at between 7.25 - 8.75%. In Pennsylvania, however, it is exempt as it qualifies as food for human consumption.

8. In Illinois, cooking wine is taxable as an alcoholic beverage, even though it's only a nominal amount and most of the time considered an "ingredient."

7. In Texas, plain nuts are exempt food, however, once a candy coating is added, they become taxable candy.

6. In Connecticut, ice is considered food, thus untaxed, whereas in Washington, it is not and is therefore taxable.

5. In Rhode Island, fruit juice that is less than 100% pure is taxable. The exception is cranberry juice cocktail, which is a mixture of juice and water or concentrate, yet is exempt.
4. In Minnesota, cough drops are taxable as "candy."

3. In California, fresh fruit is exempt, but an apple purchased through a vending machine is taxable at 33%.

2. In New Jersey, naturally carbonated water is exempt, but artificially carbonated water is taxable.

And the Top Craziest Sales Tax Law is: (Drum roll....)

1. In Pennsylvania, State and U.S. flags are not subject to tax. However, if either of these flags is sold with "accessories" (i.e. a pole), the entire purchase becomes taxable.

And now, The Funniest Tax Deduction of All

I know it sounds outrageous. I'm certainly not supporting it! But animal sacrifice may actually be a tax-deductible medical expense, if it s part of a religious ceremony for healing purposes.

Here is how the 'logic' of our tax code leads to this conclusion:

There is no question that medical expenses are deductible.
The IRS and the Tax Court have approved medical deductions for religious healing ceremonies. These include Christian Science Practitioner Fees and Native American Healing Rituals.
Under the same logic, voodoo and Santeria animal sacrifice should be deductible so long as the ceremony is for healing purposes. This includes the cost of the animals, plus the costs of food, cages, veterinary care, and other related items.

Besides - do you want to tell the voodoo queen she can't deduct her chickens?