Today is Tax Day in the U.S., and to cope with the complicated tax code and to maximize deductions, Americans are increasingly relying on third-party vendors like Turbo Tax to fill out forms. That’s not necessary in places like the U.K. and Denmark, where the government fills out forms for you. In Russia, citizens don’t have to file because the nation has a flat tax. Worldview's Jerome McDonald spoke to David Stewart, a legal editor with the publication Tax Analysts, who explained to the origins of the peculiar system used in the United States.
In 1862, the original incarnation of America's current tax system was created to pay for the Civil War. It was removed ten years later, but reinstated in some capacity in the 1890s. In 1895, however, the Supreme Court ruled it unconstitutional, and it was not until the 16th amendment, passed in 1913, that a model of the tax system we use today was created. It was set up with seven tax brackets, which ranged from 1 to 7 percent.
That our tax system was developed during a war is surprisingly not uncommon. Taxes are commonly increased during wars, Stewart says. For example, the 1800 tax in Britain was instilled to pay for the Napoleonic Wars: “It seems to always come up as a war tax, but remains after the war,” Stewart says.
Tax systems around the world
The United States system of self-reporting is fairly unique compared to other countries. In the United Kingdom, tax authorities essentially do everyone's taxes for them, which works well for wage-earners who don't have a lot of investment income. Stewart calls this a strong system "until it doesn't work," citing last year's debacle in Britain, when 1.4 million citizens owed 1,500 extra pounds because they hadn't been assigned the right tax bracket.
In Eastern Europe, most post-Soviet Union nations use a flat tax. Though this system sounds ideal, Stewart notes that it really works best in nations that have trouble collecting from their citizens. In contrast, France has no income tax withholding but expect their residents to keep enough money on hand to pay the past year in taxes in three lump sums, which bears resemblance to the United States self-employment tax.
One of the best examples of the damage a faulty tax system can do to a country's financial status are the recent financial woes of Greece, where the high rate of tax evasion directly contributed to their recent recession and subsequent bailout. "There was a certain level of corruption in the Greek tax administration," said Stewart. But there was also "a culture of tax evasion. Essentially, when you see that your neighbor is not paying taxes, you're much less likely to do so yourself."
The United States System
In the United States, citizens have become acclimated to receiving large refunds every year from taxes overpaid the previous year. For 2010, the average refund will be 3000 dollars; in Canada, 1500 Canadian dollars. Stewart noted that it is the "pecularity" of the United States system that has led to the American mindset that refunds are commonplace in the rest of the world.
The Senate Finance Committee has also recently explored how our sophisticated reporting requirements ultimately require many taxpayers to pay to file their taxes through systems such as TurboTax or H&R Block. Despite this, the U.S. has a relatively high rate of compliance, and only 1 percent of taxpayers will face an audit in a given year. This is because, according to Stewart, "information is the biggest driver of tax compliance." By constrast, in the developing world, there is very little accountability, and tax evasion runs rampant.
The U.S. also has the second highest corporate tax rate in the world; however, the effective tax rate is much lower, due to adopted workarounds put in place by corporations. The Obama administration seems to have taken on corporate tax reform as a major initative, but Stewart says, "Whether they can get it passed is an open question. But the simple fact that they’re talking about it is a positive sign."
Is there an ideal tax system? Stewart was quick to note that, "There’s no tax system that anyone will ever say ‘I really want to be involved in that.’ It is a fact of life in taxes that there will always be winners and losers."