Candice Horbacz
The Tax Foundation has released its latest comprehensive analysis, Options for Reforming America’s Tax Code 3.0, a detailed examination modeling the economic, distributional, and revenue effects of 86 distinct modifications to the nation’s tax laws. This extensive guide underscores simplicity as a foundational principle for sound tax policy, advocating for a system that is both easy for taxpayers to navigate and efficient for governments to administer and enforce. While the book presents a spectrum of reforms, some of which might introduce further complexity, a significant portion focuses on critical simplifications designed to alleviate the considerable burdens currently faced by individuals and businesses alike.
The persistent challenge of tax code complexity in the United States has long been a subject of bipartisan concern. Decades of legislative additions, carve-outs, and targeted incentives have transformed the federal tax code into an intricate web, demanding immense time and resources from both taxpayers and the Internal Revenue Service (IRS). Estimates from organizations like the National Taxpayer Advocate frequently highlight the millions of hours and billions of dollars spent annually on tax preparation and compliance. This growing complexity not only frustrates ordinary citizens and small businesses but also creates inefficiencies that can distort economic decisions and hinder growth. The Tax Foundation’s latest publication serves as a timely intervention, offering concrete pathways to unwind some of these complexities and foster a more transparent and equitable system.
Dismantling Parallel Tax Systems: The Alternative Minimum Tax (AMT)
Among the most significant simplification proposals is the outright elimination of both the Individual Alternative Minimum Tax (Option 38) and the Corporate Alternative Minimum Tax (Option 74). These parallel tax systems, colloquially known as AMTs, were originally conceived to ensure that wealthy individuals and profitable corporations could not avoid paying a minimum level of tax, regardless of the deductions and credits they claimed under the regular tax code. While seemingly addressing a fairness concern, their implementation has resulted in a separate, often more complex, calculation requirement for affected taxpayers, essentially forcing them to determine their tax liability twice.
The Individual AMT has a long and storied history, first enacted in 1969 amidst public and congressional outrage over reports that a small number of high-income individuals paid little to no federal income tax. Over the decades, it expanded its reach, catching more middle-income taxpayers than originally intended, prompting numerous legislative adjustments. Most recently, the Tax Cuts and Jobs Act (TCJA) of 2017 significantly curtailed its impact by raising exemption amounts and phase-out thresholds, limiting its application to a much smaller segment of the population. The Congressional Budget Office projects that fewer than 600,000 taxpayers, or approximately 0.3 percent of all returns, will be subject to the individual AMT in 2026. Despite its reduced scope, its administrative burden remains disproportionately high for those affected, with the National Taxpayer Advocate famously stating that it "nearly doubles the burden of filing a federal income tax return." The Tax Foundation argues that its elimination would significantly simplify filing for these individuals, removing an antiquated and inefficient mechanism.
The Corporate AMT followed a similar trajectory. Established in 1986, it was intended to prevent profitable corporations from using various tax preferences to reduce their tax liability to zero. However, it too proved burdensome and was ultimately repealed by the TCJA in 2018, simplifying the corporate tax landscape at the time. Yet, the concept was resurrected in 2022 with the passage of the Inflation Reduction Act, which introduced a new Corporate AMT requiring large corporations (those with average annual financial statement income exceeding $1 billion) to pay a minimum tax of 15 percent on their adjusted financial statement income. This reintroduction, under a different set of rules, has already led to significant compliance challenges for U.S. companies, as reported by the Tax Executives Institute, while generating relatively little new revenue compared to initial projections.
The Tax Foundation’s proposal to eliminate both AMTs is rooted in the principle that true simplification involves addressing the root causes of low effective tax rates rather than layering on complex patches. Policymakers concerned about potential revenue losses or perceived inequities could instead focus on reforming or eliminating specific tax preferences—deductions and credits—that contribute to these outcomes. This approach would replace the cumbersome parallel systems with a single, clearer set of rules, fostering greater transparency and reducing compliance costs for both individuals and businesses. The implications of such a move would extend beyond mere simplification, potentially freeing up resources for innovation and growth within the private sector by reducing the time and money spent on navigating complex tax provisions.
Streamlining Savings: The Case for Universal Savings Accounts (USAs)
Another area ripe for simplification, according to the Tax Foundation, is the convoluted landscape of tax-advantaged savings vehicles (Option 39). The current U.S. tax code features a myriad of specialized accounts, each designed with different rules, contribution limits, withdrawal conditions, and eligibility criteria. While many Americans are familiar with popular options like 401(k) plans and Individual Retirement Accounts (IRAs) for retirement savings, the universe extends to Health Savings Accounts (HSAs) for medical expenses, Flexible Spending Accounts (FSAs) for healthcare and dependent care, and 529 plans for educational expenses, among others. Over recent years, lawmakers have even proposed adding more niche accounts for specific purposes such as first-time homeownership, lifelong skills development, or disaster recovery.
This proliferation of savings accounts creates significant administrative burdens for taxpayers, requiring intricate tracking, managing multiple accounts, and navigating complex rules to avoid penalties. For the IRS and the Treasury Department, it translates into increased administrative overhead for oversight and enforcement. Moreover, this highly fragmented system often violates the principle of neutrality, a cornerstone of sound tax policy. By offering preferential tax treatment only to certain types of saving (e.g., retirement, healthcare, education), the tax code inadvertently steers individuals toward specific savings behaviors while leaving other forms of saving subject to higher effective tax rates. This can lead to inefficient allocation of capital and personal finances, as decisions are influenced more by tax advantages than by individual needs or market signals.
The Tax Foundation’s proposal advocates for the establishment of Roth-style Universal Savings Accounts (USAs). Under this model, individuals would be permitted to contribute a specified amount post-tax—for example, $10,200 in 2027, indexed for inflation thereafter—into a single, flexible savings vehicle. The key advantages of USAs include tax-free growth on contributions and the ability to make withdrawals at any time, for any reason, without penalty or further taxation. Unused "contribution room" could also be carried forward to subsequent years, offering greater flexibility. Crucially, withdrawals would replenish contribution room, allowing for a dynamic approach to saving and spending throughout one’s life.
To achieve maximum simplification, the proposal suggests phasing out the use of other existing tax-advantaged accounts like HSAs, FSAs, and 529 plans. While this transition would require careful planning to protect existing account holders and ensure a smooth shift, the long-term benefits include a dramatically simplified savings landscape. A single, versatile USA could empower individuals to save more effectively for a broad range of life goals without needing to master the intricacies of multiple specialized accounts. This reform could foster greater financial literacy, encourage broader participation in savings, and reduce the tax-induced distortions that currently influence personal financial decisions, ultimately leading to a more robust and adaptable economy.
Refocusing Social Safety Nets: EITC and CTC Reform
The Earned Income Tax Credit (EITC) and the Child Tax Credit (CTC) are two of the largest federal programs designed to support low- and middle-income families, yet their current design presents significant complexities for taxpayers and administrative challenges for the IRS (Option 21). The CTC, for instance, offers up to $2,200 per child in 2026, with phase-outs for higher-income single ($200,000+) and joint ($400,000+) filers. The EITC, intended to "reward work," provides a credit for low-income workers, with the amount varying based on filing status and the number of qualifying children.
The primary issue is that the EITC, despite its original intent, now functions in many respects as a second child tax credit. The maximum childless credit is a relatively modest $664, whereas a taxpayer with one child can receive up to $4,427. This dual function, combined with distinct and often overlapping eligibility criteria, creates a maze of rules. The EITC has complicated phase-in and phase-out schedules, designed to encourage work but often leading to confusion. Adding to this complexity are the differing definitions of a "qualifying child": children are eligible under the EITC through age 18 (or 23 if a full-time student), but only through age 16 for the CTC. These discrepancies mean that families with children nearing these age cutoffs must navigate different rules for two credits that appear similar on the surface. Such complexity leads to high error rates, increased audit risk for taxpayers, and significant administrative burdens for the IRS.
The Tax Foundation’s proposal seeks to reform the EITC and CTC by clearly separating their functions: one credit would be strictly a work credit, and the other strictly a child credit. This fundamental restructuring aims to simplify eligibility, clarify incentives, and reduce the administrative burden on both taxpayers and the IRS. While the specific parameters of such a reform would need careful calibration, the core idea is to eliminate the overlapping functions and confusing rules that currently characterize these vital social programs.
By disentangling these credits, the reform could make it easier for eligible families to claim the benefits they are due, reducing errors and potentially increasing participation among those who currently find the application process too daunting. It would also provide a clearer signal to taxpayers about the purpose of each credit, enhancing transparency. For policymakers, this simplification would offer a more direct way to achieve specific policy goals—either to support families with children or to incentivize work—without the unintended consequences of complex interactions between two different programs. Such a reform would represent a significant step towards a more rational and effective social safety net delivered through the tax code.
Unlocking Investment: Full Expensing for All Capital Assets
A fundamental aspect of business taxation that profoundly impacts investment decisions is how capital expenditures are treated. The Tax Foundation’s Option 53 proposes enacting full expensing for all capital investment, a reform that would dramatically simplify the tax code and stimulate economic growth. Under an idealized cash flow tax, businesses would immediately deduct all expenses incurred in the course of doing business. However, the current U.S. tax code deviates significantly from this principle, particularly concerning capital assets. While many operating expenses, such as wages, and even some capital investments like machinery and equipment, can often be fully deducted in the year they are incurred or purchased, buildings and other structures must be depreciated over many years.
Depreciation is an accounting method that spreads the cost of an asset over its estimated useful life. While this reflects the economic reality of assets losing value over time, tax depreciation schedules are often arbitrary and do not align with actual economic depreciation. The problem is exacerbated by the sheer complexity of these schedules, which vary widely based on asset type, industry, and even date of acquisition. Businesses must navigate a labyrinth of rules to determine how to depreciate different assets, leading to increased paperwork, significant tax planning costs, and frequent disputes with the IRS. This complexity is not merely an administrative nuisance; it has real economic consequences.
By requiring businesses to deduct the cost of long-lived assets over many years instead of immediately, the current system effectively raises the after-tax cost of investing in those assets. The present value of a future deduction is less than that of an immediate deduction due to the time value of money and inflation. This disincentive particularly affects investments in structures, which typically have very long depreciation periods. As a result, businesses are less likely to undertake certain investments, leading to reduced capital formation, slower productivity growth, and ultimately, lower wages for workers. Economic research consistently shows that full expensing alleviates this bias, incentivizes greater investment, and fosters a more dynamic economy.
The proposal to allow full and immediate deductions for all capital assets, including structures, would eliminate the need for complex depreciation schedules entirely. A $100 expense would consistently result in a $100 deduction in the year of the expense, irrespective of the asset type. This simplification would not only drastically reduce compliance costs for businesses but also neutralize the tax code’s bias against long-lived investments. By making all capital investments immediately deductible, the reform would lower the cost of capital, encourage businesses to invest more in new technology, equipment, and infrastructure, thereby boosting innovation, creating jobs, and enhancing overall economic competitiveness. While there would be a short-term revenue impact, economic models suggest that the long-term gains from increased investment and economic growth would largely offset these initial costs, making full expensing a powerful pro-growth reform.
Eliminating Double Taxation: Corporate and Individual Tax System Integration
A critical structural inefficiency in the U.S. tax code, highlighted by the Tax Foundation, is the double taxation of C corporations, a problem addressed by Option 60: integrating the corporate and individual tax systems through a dividend deduction. The current system distinguishes between C corporations and "pass-through" entities like sole proprietorships, partnerships, S corporations, and Limited Liability Companies (LLCs). While pass-through businesses constitute the vast majority of U.S. enterprises, their profits are not taxed at the entity level; instead, they "pass through" directly to the individual owners, who then pay individual income tax on their share of the business’s profits. This results in a single layer of taxation for pass-through income.
C corporations, however, face a different fate. Their profits are first taxed at the corporate level (currently at a 21 percent federal rate). Then, when these after-tax profits are distributed to shareholders as dividends, or when shareholders sell their stock at a capital gain reflecting retained earnings, those distributions are taxed again at the individual shareholder level. This "double taxation" discourages investment in C corporations, distorts capital allocation, and often prompts businesses to structure themselves as pass-through entities primarily for tax reasons, rather than for optimal operational efficiency. It also encourages C corporations to retain earnings or borrow rather than distribute profits, which can lead to suboptimal capital structures.
The existence of two distinct business tax systems—one with a single layer of taxation and another with a double layer—introduces significant complexities and inefficiencies into the U.S. economy. It creates an uneven playing field, incentivizes tax-driven legal structuring, and can make the U.S. less attractive for capital investment compared to countries with integrated tax systems.
The Tax Foundation’s proposal offers a straightforward solution: allow C corporations to deduct the dividends they pay to their shareholders. This reform would effectively eliminate the second layer of taxation on corporate profits. By allowing C corporations to deduct dividends, their distributed profits would only be taxed once, at the shareholder level, mimicking the single-layer taxation structure of pass-through entities.
The implications of such an integration are profound. It would significantly reduce distortions in the tax code, removing a major tax bias against C corporations. This would encourage more efficient capital allocation, as businesses would be less inclined to make structuring decisions based primarily on tax considerations. It could also lower the cost of capital for C corporations, stimulating investment and potentially leading to higher stock valuations and greater economic dynamism. Furthermore, it would simplify the overall business tax landscape, bringing policymakers closer to the ideal of a unified set of rules and rates for all U.S. businesses, fostering a more level and competitive economic environment.
The Path Forward: Prioritizing Simplicity in a Complex Landscape
The U.S. tax code, despite periodic attempts at reform, has largely trended towards increasing complexity over recent decades. While the Tax Cuts and Jobs Act of 2017 did introduce some notable simplifications, particularly in the individual and business spheres, the legislative environment frequently introduces new carve-outs, specialized savings vehicles, and targeted tax increases, each adding another layer to an already intricate system. This continuous accretion of rules creates a growing burden on taxpayers, drains resources from the IRS, and introduces economic inefficiencies that hinder growth and fairness.
The reforms outlined in the Tax Foundation’s Options for Reforming America’s Tax Code 3.0 demonstrate that a simpler tax code is not only attainable but also highly desirable. By tackling systemic issues like parallel tax systems (AMTs), fragmented savings accounts, overlapping social credits (EITC/CTC), outdated capital investment rules (depreciation), and double taxation of corporate income, policymakers have clear, analytically supported pathways to reduce complexity. These options, while presenting their own political and transitional challenges, represent fundamental shifts toward a more coherent, efficient, and equitable tax system.
Embracing simplicity in tax policy would yield substantial benefits: lower compliance costs for individuals and businesses, enhanced clarity in tax obligations, reduced administrative burden for the government, and a more neutral tax code that encourages economically beneficial activities like saving and investment. The Tax Foundation’s detailed analysis provides an invaluable resource for lawmakers and the public, offering a rigorous framework to understand the trade-offs and potential gains associated with each reform. As the national dialogue on fiscal policy continues, the imperative to prioritize a simpler, more growth-oriented tax code remains a critical objective for the nation’s economic future.
