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Tax Law Meets Moore’s Law

4 min readBy: Scott Hodge

A frequent complaint of corporate taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. professionals is the difficulty in managing the realities of today’s ever-changing technology with the rigid rules imposed by an industrial era tax code. How, for instance, do companies square the law of straight-line depreciationDepreciation is a measurement of the “useful life” of a business asset, such as machinery or a factory, to determine the multiyear period over which the cost of that asset can be deducted from taxable income. Instead of allowing businesses to deduct the cost of investments immediately (i.e., full expensing), depreciation requires deductions to be taken over time, reducing their value and discouraging investment. –which requires them to depreciate high-tech equipment over five years–with Moore’s law, which states that the speed and power of a computer chip will double every eighteen months?

Individual taxpayers are also discovering that the tax code is out of step with the changing composition of the “typical” family. A soon to be released report by the U.S. Census Bureau shows that for the first time ever, the number of families with children in which both the husband and wife work is now greater than the number of single-earner families. Moreover, 55 percent of these dual-income couples had annual incomes of $50,000 and over, compared to 40 percent of the single-income couples.

The rise in dual-income couples likely explains the popularity of repealing the so-called marriage penaltyA marriage penalty is when a household’s overall tax bill increases due to a couple marrying and filing taxes jointly. A marriage penalty typically occurs when two individuals with similar incomes marry; this is true for both high- and low-income couples. . It may also explain why some polls show that voters are unmoved by the highly publicized charges that Governor George W. Bush’s tax cut plan would deliver most of its benefits to the “richest” taxpayers. The fact is that many of these dual-income couples have actually entered tax bracketA tax bracket is the range of incomes taxed at given rates, which typically differ depending on filing status. In a progressive individual or corporate income tax system, rates rise as income increases. There are seven federal individual income tax brackets; the federal corporate income tax system is flat. s that were once reserved only for the “rich.”

The latest Internal Revenue Service data shows that the threshold for entering the top 25 percent of all taxpayers–who pay about 83 percent of all income taxes–is $50,607. Based on Bureau of Labor Statistics surveys of occupational earnings, an average-paid kindergarten teacher married to a entry-level firefighter would easily find themselves within the top 25 percent of taxpayers.

Should this school teacher become an assistant principal and the firefighter become an assistant fire chief, their combined income of $97,106 would easily surpass the $83,200 threshold to enter the top 10 percent of all taxpayers. While folks in these professions may never reach the $269,496 in earnings it would take to put them into the top one percent of taxpayers, they are not far from the $114,729 threshold that would put them into the top five percent.

Ironically, while these families are clearly in the “elite” of taxpayers, most if not all still consider themselves solidly middle class. So imagine their surprise when they learn that they earn more than the political definition of middle class and are thus ineligible for many of the “targeted” tax cuts promoted by candidates this year–including most of the measures in Al Gore’s tax cut plan.

The proliferation of tax creditA tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly. s in recent years has also had the unintended consequence of increasing the number of families with Alternative Minimum Tax (AMT) liabilities. According to the Joint Tax Committee (JTC), there are currently about one million taxpayers affected by the AMT, but that number is expected to rise to 10.5 million by 2010 under current law. JTC determined that Bush’s tax cut plan would increase the number of AMT-affected taxpayers by 16 percent by 2010. While JTC has not performed a similar analysis of the Vice President’s tax plan, it is a certainty that Gore’s credit-laden plan would exacerbate the AMT problem to an even greater degree.

Estate taxAn estate tax is imposed on the net value of an individual’s taxable estate, after any exclusions or credits, at the time of death. The tax is paid by the estate itself before assets are distributed to heirs. repeal is another issue that has transended traditional class lines because of the rise of a new class–the investor class. During this years’ congressional debate over Rep. Jennifer Dunn’s estate tax repeal legislation, many mainstream journalists marveled at the breadth of bi-partisan support she had garnered. But the old model doesn’t work any longer. With more than half of all American households now invested in the stock market, lawmakers are realizing that millions of average families (who vote) are reconsidering the fairness of the estate tax. Some obviously think they could save enough to be hit by the tax, and some may own a home whose appreciated value will put them over the top; but many have simply rethought the issue and concluded that the tax is unfair on principle.

Of course, the hallmark of the New Economy are the Internet entrepreneurs working out of their basements in the hopes of designing the next dot-com success story. But a recent General Accounting Office report indicates that these would-be e-millionaires are spending as much time complying with the tax code as they are writing computer code. GAO found that a small business can face up to 200 different IRS forms, schedules and requirements depending on how they organize, if they hire employees, and what kind of products or services they plan to offer.

Doubters will say that the near-term prospects of Washington enacting fundamental tax reform are slim to none–even should a candidate who supports reform be elected. But the daily evidence that the current tax code is incompatible with the vibrant and dynamic New Economy may force Washington to stop talking about the problem and start solving it.