The Tax Reform Proposals: Some Good Ideas, but Show Me the Money
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The Tax Reform Proposals: Some Good Ideas, but Show Me the Money ho can doubt that the U.S. need to raise substantially more revenue in the debate and lay the groundwork for future reform needs a better tax system? future than we have raised in the past. discussion. We need simple and con- sistent rules, adequate reve- The President’s Advisory Panel on Federal Tax All of this comes with an enormous caveat, nues to finance government Reform recently released two plans. The first though. The Panel compares its proposals Wspending, equitable tax burdens across and is the simplified income tax (SIT). The second to a tax system that is not based on current within economic groups, and favorable incen- is a combination of a consumption tax (based law, but rather that starts with current law tives for productive activity. on the late David Bradford’s X-tax) and an and then assumes that massive, regressive individual-level surcharge on capital income. tax cuts take place. Relative to this straw- On top of these ongoing concerns, we Both plans would make tax rules simpler and man baseline, the Panel claims its proposals currently need to deal with the imminent more consistent, eliminate the AMT, eliminate would be revenue-neutral, distributionally- explosion of the alternative minimum tax, the most tax expenditures, and cut the effective neutral, and growth-enhancing. Relative to looming expiration of all recent tax cuts, and tax rate on capital income. The second plan the real world, though, the effects likely are the inconvenient fact that unless we cut future reduces capital taxes by more than the first does, far less auspicious. entitlement spending dramatically, we will but both plans combine features of income and consumption taxes. THE SIMPLIFIED INCOME TAX PLAN he SIT would replace numerous family pro- Leonard Burman is Senior Fellow at the Urban Institute. William The plans creatively blend old and new ideas visions with a family credit and refundable Gale is the Arjay and Frances Fearing Miller Chair, Brookings T Institution. The authors are Co-Directors of the Urban-Brookings and the overall report has the potential to work credit. This would simplify tax calcula- Tax Policy Center (www.taxpolicycenter.org). usefully stretch the boundaries of the public tions for low-income households. © The Berkeley Electronic Press Economists’ Voice www.bepress.com/ev December, 2005 -1- The Panel would convert the mortgage interest more lucrative for low- and middle-income revenue loss over the next few years (because deduction to a 15 percent credit, reduce the households. Evidence suggests that such contributions would not be deductible), but cap on eligible interest payments, subject to households need to save more for retirement substantial losses in the long-term (because adjustment for regional variation in housing and that, unlike the higher-income households withdrawals are not taxable). The proposal also prices. These changes would increase by 60 who currently garner most tax subsidies for includes a rollover provision that would cost percent the number of people who benefit saving, their contributions to tax-preferred about $1.30 in lost future revenue (in present from mortgage subsidies—mostly lower- and saving plans are more likely to constitute new value) for every dollar raised in the short run, middle-income households. By expanding saving (rather than asset shifting). as Orszag and we showed in prior research. the scope of the subsidy to these groups, the proposed credit could have more impact On the other hand, the proposals would Both proposals would repeal the AMT, a on homeownership rates than the current, massively expand Roth IRAs. A family of four complex and inefficient tax. Repeal, however, skewed subsidy. would be able to contribute $60,000 per year is both expensive and regressive (because to back-loaded saving plans for retirement, eliminating the AMT would allow many high The proposed repeal of the state and local tax health, education, and housing. As Peter income filers to pay lower taxes). It would deduction will create howls of protest, much as Orszag and we have explained, such changes be possible to redesign the AMT in a manner the limitations on mortgage interest deductions, would be extremely regressive and would be that is revenue-neutral and return the AMT to but by 2010 under current law there would be unlikely to raise saving very much. Only high- its original purpose of closing tax shelters, as very little effective deduction anyway, because income, high-wealth taxpayers would benefit Jeff Rohaly and we have shown. When policy the AMT would take it back for many high from eliminating income limits and raising makers and the public see the policy changes income taxpayers and most others do not contribution limits. Evidence suggests that such required to regain the revenue lost from AMT itemize deductions, as Kim Rueben, an Urban households are much more likely to use these repeal, they may well opt to retarget the tax Institute economist, has shown. accounts as tax shelters than as avenues for new rather than repeal it. saving. In addition, the proposals could make On the saving side, the panel would encourage the employer pension system less attractive The SIT would exempt individual taxation automatic or opt-out 401(k) plans and for business owners and thus reduce pension of corporate dividends to the extent that the restructure the saver’s credit to be refundable coverage among low- and middle-income firm’s profits are taxable in the United States. and to phase out gradually with income. These households. Finally, the proposals would not Capital gains on corporate stock would get a proposals would make saving simpler and be massive budget gimmicks. They have little 75-percent exclusion. In exchange for these Economists’ Voice www.bepress.com/ev December, 2005 -2- reductions, the corporate tax base would be $10 million) and large companies. These One way to get to the X-tax from the SIT is broadened substantially, eliminating virtually may be the most fundamental changes in the to drop all taxation of capital income at the all special deductions and credits. That is, report. Additional details are needed to assess individual level, and, at the business level, the panel aims to take seriously the “tax all these features, however, as obvious avoidance change depreciation to expensing, eliminate corporate income once” part of corporate strategies appear to be feasible. deductions for interest payments and the integration schemes as well as the “tax it only taxation of interest income. As the panel once” part that tax cutters like to emphasize. The plan would also move to a territorial emphasizes, the link between expensing and The plan would impose individual rates system, under which the U.S. would not removal of interest deductions is critical for ranging from 15 to 33 percent, and a top tax firms’ active foreign business income or well-designed reform, since doing the first corporate rate of 31.5 percent. allow deductions for foreign expenses. Again, without the second would generate negative the devil is in the details, but this could be effective tax rates on capital (that is, huge tax But there is no reason for the plan to give an improvement over the current system, shelter opportunities). There are some changes dividend relief to owners of old capital, who especially under tight rules for allocating to rates relative to the SIT and transition bought their shares knowing they were subject income and expenses, and under the panel’s relief is provided to generate the “progressive to double taxation and hence paid less than they proposal to determine a firm’s residency by consumption tax” in the panel report. Because would have under an integrated system. There the location of its main operations, not its the report aims to provide new ideas, not is no efficiency or equity purpose to the windfall titular headquarters. A concern, however, is necessarily legislative proposals, the options gain provided, and the loss in revenue requires that under the proposal foreign income would would have been quite clear had the report higher rates and a resulting loss of efficiency be exempt from U.S. taxation even if it were stopped at this point, and simply portrayed the everywhere else. Nor is it clear that the SIT not taxed abroad. This would vastly increase progressive consumption tax as an alternative would tax all corporate income once, since it incentives to relocate income to tax havens. to the SIT. leaves intact the tax differences between debt and equity that create so much tax mischief. THE GROWTH AND INVESTMENT TAX PLAN Instead, in order to reach a unanimous vote, here is a broad, but not universal, consensus the panel changed the progressive consumption The plan offers new and interesting models Tamong public finance experts that if we go tax in several ways, including adding back to streamline and simplify business taxation, to a consumption tax, the X-tax is the way to go. a 15 percent tax on individuals’ interest, with different rules for small (revenue less The X-tax is just the Hall-Rabushka flat tax with dividends and capital gains; and retaining the than $1 million), medium (revenues less than graduated tax rates on wage income. backloaded savings accounts mentioned above. Economists’ Voice www.bepress.com/ev December, 2005 -3- The resulting mix—the Growth and Investment that assumes both that the enacted Bush the revenue profiles from its proposals would be Tax—is difficult to characterize and hence will tax cuts, which are currently scheduled to flatter over time than the Bush policy baseline. confuse the public. expire after 2010 or earlier in some cases, This means that even if the plans are revenue- are made permanent and that all of the other neutral relative to the Bush-budget baseline over REVENUE tax cuts in the President’s budget are enacted, the next decade, the plans raise less revenue in he report’s claim that the plans are rev- including very large Roth IRAs and Lifetime 2015 than the Bush-budget baseline would, and Tenue-neutral needs to be taken with a Saving Accounts.