It would be interesting to gather reader perspectives on the most perverse things about the U.S. tax code. Here is my personal list of things that stick out either because they affect a lot of people or have big dollar signs attached.
That child care expenses are not fully deductible from income. Suppose that a parent works to earn $40,000 per year and pays a nanny $40,000 per year to stay home with the children. As the family is no better off financially than when the parent stayed home personally, why is the family paying more in taxes? Maybe the argument is that the family gets a huge emotional and personal benefit from having a child around and therefore the nanny costs are personal rather than work-related? But if that is true, why are children treated as an economic burden with no emotional or personal value when it comes time to award child support to the parent victorious in a custody lawsuit?
That a person who collects $100,000 per year in child support, more than 20X what a typical married couple spends on a child (see previous posting regarding on UCLA research), can claim that child as a financial “dependent.”
That child support, which in many states functions by design in the same way as alimony, is treated differently from a tax perspective (tax-free to the plaintiff, not taxable to the defendant). Once child support exceeds the USDA-estimated cost of rearing a child, why wouldn’t the IRS treat the excess as alimony-in-fact? (Separately, why hasn’t the IRS addressed the apparent discrepancy between the 567,887 Americans who report paying alimony and the roughly 300,000 who report receiving it, with the result that taxpayers who were not divorce litigants must pay a larger share of their income in tax to make up the shortfall? (treasury.gov report).)
That health care costs, which are nearly 20 percent of the GDP, are deductible or not depending on a huge array of factors, e.g., whether the employer or the employee pays or whether or not one is self-employed. For such a huge sector of the economy one would expect that there would be agreement on whether these should be pre-tax or post-tax expenses. (Personally I think it is madness to pour gasoline on the health care bonfire of cash by making the dollars spent mostly pre-tax. If an industry is consuming an outsized portion of GDP why encourage Americans to keep pouring more money into it? It is also a big hit to the tax base. The government is very careful to limit charitable deductions as a percentage of income but is allowing 20-30 percent of income, for a lot of workers, to be swept off the taxable table.)
Allowing some money managers to claim their fees as capital gains rather than ordinary income. (The “carried interest” stuff that is periodically debated by politicians.) If the point of having a long-term capital gains rate is to ameliorate the fact that inflation-driven pseudo-gains are taxed (see below) and to encourage people to invest in businesses, why give the rate to people who did not put up personal funds and who did not hold an asset long enough for inflation to be an important factor?
That capital gains are not adjusted for inflation (so we pay the same tax on an asset that doubled in nominal value over the past year and on an asset that doubled in nominal value over the past 50 years (i.e., actually lost value because of 50 years of inflation)). This will lead to some crazy behavior if we ever get back to Jimmy Carter-era levels of inflation.
That successful people who lead short lives have a much larger percentage of their income taxed away compared to people who enjoy a long life. This is because the estate tax is a second income tax, taking a cut of money that was already taxed as it was earned. (See Mankiw for how these add up.) Someone who dies during his or her working years is much more likely to pay estate tax than someone who dies following a long retirement in which savings accumulated during working years were spent. [Financially unsuccessful Americans don’t pay any estate tax, of course, because the threshold is pretty high.]
After we (permanently?) melted down our economy with a housing bubble and while we continue to melt the planet by heating and air conditioning double the number of square feet per person that we lived in during the middle of the 20th Century, we continue to subsidize expenditures on housing with the mortgage interest deduction.