Review of Tax Reform Proposals –

By: Larry Walker, Jr. –

I am in agreement with the Fiscal Commission’s goals on tax reform. Although the details are a little vague, it’s clear to me that Option 1 is probably out of the question, Option 2 is promising, and Option 3 is pretty much a joke. I think that those who have discounted this initial ‘draft’ report at face value are doing the commission a disservice. And as far as the Trash Talker In Chief, who has already started spouting off without even reading it, I have nothing but contempt for the comments I heard today out of South Korea.

I personally had a falling out with President Bush, when he put together a special commission on the War, and then proceeded to ignore everything they said. So I hope that someone in Washington takes this commission seriously and implements some of their more excellent ideas (the right ones). If not, there will probably be another major falling out.

Of course, the following tax reform proposals go along with proposed cuts in spending. I am just looking at the tax aspects today, but as long as spending is cut as proposed, there is hope of some kind of compromise on taxes. I think we do need to simplify our tax code and lower tax rates however, our main problem right now is spending. Thus, spending reform should occur prior to any type of tax reform, and of course the repeal of Obamacare is number one on that list. At the top of the tax reform list today is passing another patch for the AMT, and extending the 2010 tax rates for another couple of years. There’s no time to waste on partisan trash talk.

My likes and dislikes are below in blue type, and a link to the original report is at the bottom.

Comprehensive Tax Reform

Goals:

• Lower Rates
• Simplify the Code
• Broaden the Base
• Cut Spending in the Tax Code (Tax Expenditures)
• Improve Compliance (Tax Gap)
• Make America the Best Place in the World to Start and Grow a Business
• Reduce the Deficit

I have no problem at all with the commissions outline of goals for comprehensive tax reform. I think they are in agreement with what every fiscal conservative has been chiming for decades.

Option 1: The Zero Plan

• Consolidate the tax code into three individual rates and one corporate rate
• Eliminate the AMT, Pease, and PEP
• Eliminate all $1.1 trillion of tax expenditures
• Dedicate a portion of savings to deficit reduction and apply the rest to reduce all marginal tax rates
• Add back in any desired tax expenditures, and pay for them by increasing one or all of the rates from their zero-expenditure low

Option 1: The Zero Plan

*Note: All options set aside $80 billion for deficit reduction and treat capital gains and dividends as ordinary income. Rates based on very rough static estimates. No behavioral effects are assumed. Magnitude of tax expenditures estimated broadly.

Although I like the idea of lowering the tax brackets and consolidating them down to the three, and having one lower rate for corporations, the elimination of all tax expenditures is problematic. Having survived through a household with four young children, I have empathy for parents of young children. Between day care, food, medical, and the extra running around that parents deal with, it would be right to extend the child tax credit. Although it wasn’t there in my day, it would have given us some badly needed relief.

I am however not a fan of the EITC (earned income tax credit). I think the EITC discourages people from being all that they can be, and instead keeps them locked within a certain range of income. So the EITC can be dumped.

I agree with repealing the AMT (alternative minimum tax), in fact, we ought to just go ahead and do that right now. And I agree with repealing the limitations on itemized deductions (Pease), and personal exemptions (PEP).

I disagree with taxing dividends and capital gains at ordinary rates. I think we should encourage investment by extending more favorable tax rates to investment income.

I would like to see the continuation of deductions for mortgage interest, property taxes, state and local income taxes, and charitable contributions.

I am in favor of keeping deductions for retirement contributions such as IRAs and SEPs which are not addressed in this summary.

Thus, Option 1 falls short of the mark because by the time one adds back all the desirable tax expenditures, we’re right back where we started. However, Option 2 is more appealing.

Option 2: Wyden-Gregg Style Reform

Individual Tax Reform

• Repeal AMT, PEP, and Pease
• Establish 3 rates –15%, 25% and 35%
• Triple standard deduction to $30,000 ($15,000 for individuals)
• Repeal state & local tax deduction, cafeteria plans, and miscellaneous itemized deductions
• Limit mortgage deduction to exclude 2nd residences, home equity loans, and mortgages over $500,000
• Limit charitable deduction with floor at 2% of AGI
• Cap income tax exclusion for employer-provided health care at the amount of the actuarial value of FEHBP standard option
• Modify and repeal several other tax expenditures
• Dedicate portion of savings to deficit reduction

Again, the repeal of the AMT, PEP, and Pease are most desirable, fundamental to both options and should be done now, today.

I like the idea of having just the three tax brackets.

The tripling of the standard deduction is very appealing. It would take the place of the mortgage interest deduction for many, allow non homeowners a higher deduction, and not impair those with larger mortgages (under $500K). I think limiting the mortgage deduction on 2nd homes and mortgages over $500K is prudent. Why are we subsidizing 2nd homes anyway?

I’m OK with the limitations on charitable contributions, and the employer health care exclusion.

I don’t know what is meant by ‘repealing several other tax expenditures.’ The commission needs to be more specific.

Corporate tax reform

• Reduce corporate tax rate to 26%
• Permanently extend the research credit
• Eliminate and modify several business tax expenditures, including:
• Domestic production deduction
• LIFO method of accounting
• Energy tax preferences for the oil and gas industry
• Depreciation rules
• International tax reform including a territorial system

The corporate tax reform ideas seem reasonable, but of course more detail is required.

Option 3: Tax Reform Trigger

• Call on Finance and Ways & Means Committees and Treasury to develop and enact comprehensive tax reform by end of 2012
• Put in place across-the-board “haircut” for itemized deductions, employer health exclusion, and general business credits that would take effect in 2013 if reform is not yet enacted
• Haircut would limit proportion of deductions and exclusions individuals could take to around 85%* in 2015. Similarly, corporations would only take some proportion of their general business credits
• Set haircut to increase over time until tax reform is enacted

*This is a very rough estimate of the haircut necessary to reduce the deficit by $80 billion in 2015

Option 3 is absolutely out of the question. Throwing tax reform back into the hands of politicians virtually assures that nothing will be accomplished for another 40 years. The use of the word ‘trigger’ pretty much sums it up. Who’s going to pull it?

Source: http://www.fiscalcommission.gov/news/cochairs-proposal