Five don't dos for tax reform
Many Americans have an unfavorable view of the US tax system; in a recent survey, only 5% of respondents said it’s “working just fine.” Achieving true tax reform, Ed Feulner (founder of Heritage Foundation), Washington Times, 4/13/15.
And no wonder, for the tax system is complicated, inefficient, and economically burdensome. Not that everyone agrees on the specifics, they surely don’t, but it’s hard to believe that anyone setting out to design a tax system from scratch would propose a system like the one that is currently in place.
Politicians on both sides of the aisle proclaim their support for tax reform, and yet the Internal Revenue Code keeps getting longer, e.g., grew from 504 pages in 1939 to 74,608 pages in 2014. Look at how many pages are in the federal tax code, Jason Russell, Washington Examiner, 4/15/15.
Then there are the far more voluminous IRS regulations, revenue rulings, etc., which have been issued to explain how the statutory provisions are interpreted and will be applied. Can anyone be considered an “expert” in all areas of the tax law these days, as opposed to say the tax aspects of corporate reorganizations or employee benefit plans? The overall tax law seems too vast a domain for the human mind to comprehend.
The driving force for tax complexity has been the practice of enacting tax preferences and penalties to influence individual and business behavior, an expedient way of keeping government costs out of the budget so they won’t be subject to close scrutiny. Putting a face on America’s tax returns, Scott Hodge, Tax Foundation, 2013 (download PDF).
Over the decades, lawmakers have increasingly asked the tax code to direct all manner of social and economic objectives, such as encouraging people to buy hybrid vehicles, turn corn into gasoline, purchase health[care] insurance, buy a home, replace that home’s windows, adopt children, put them in daycare, purchase school supplies, go to college, invest in historic buildings, spend more on research, and the list goes on. The growth in social and economic policy driven through the tax code has made the IRS a super-agency, duplicating the work of every other cabinet agency, from Energy and Education to HHS and HUD.
If Americans want real tax reform, as they should, here are some pitfalls that need to be avoided.
1. Don’t count on “silver bullet” solutions – It may sound hip to talk about repealing the tax code and instituting a brand new tax system, such as a “flat tax” in which all income would be taxed at the same rate. Not only would the paperwork be vastly simplified, but proponents typically imply that most everyone’s tax burden would be reduced.
Senator Ted Cruz paints a glowing, all upbeat picture. Statement on tax day, 4/15/15.
Instead of a tax code that crushes innovation and inflicts burdens on families struggling to make ends met, imagine a simple, flat tax that lets Americans fill out their taxes on a postcard. Imagine a tax code that is simple enough to abolish the IRS. More of Americans’ hard-earned wages should be able to stay in their wallets so they can be free to invest more in their families and businesses, not in growing big government.
Senator Rand Paul at least cites a tax rate (17%) although it might not be high enough. One might question the practicality of the spending cuts he seems to be calling for, not to mention the prospects for a balanced budget amendment to the Constitution. Rand Paul means business on tax reform, localnews7.com (Chicago Tribune story), 4/15/15.
On the campaign trail, he’s advocating for a flat tax that, without exemptions, would tax an individual at the rate of about 17 percent. If implemented, economists suggest his plan would force government to spend less; government currently spends at a flat-tax rate of about 25 percent per individual. Paul would eliminate most tax breaks and make investment income tax-free. He’s also trying to sell a constitutional amendment for a balanced budget.
Requiring everyone to pay tax at the same rate versus putting a proportionally bigger burden on high earners would be a sure-fire political loser, and has not actually been proposed by anyone that we know of. In Steve Forbes’s flat tax plan, for example, it was envisioned that personal exemptions would be increased with the result that only half of working Americans would be on the tax rolls. Accordingly, the effective tax rate would vary from 0% to nearly 17% for very high earners. Flat tax revolution, Steve Forbes, 2005.
Another “silver bullet” idea is the so-called FairTax, which would replace the Federal income, payroll (and also self employment), corporate and death taxes with a Federal sales tax levied at a rate (perhaps 23% of purchase amounts) designed to raise the same amount as the several taxes eliminated. To ensure that the upshot was not a federal sales tax and an income tax, the 16th Amendment (which empowered Congress to levy an income tax) would be repealed.
As a means of tempering the regressivity of the FairTax, consumers would receive, in equal monthly installments, an annualized rebate on poverty level (determined by the Government for the household size) expenditures. It isn’t hard to imagine the size of the bureaucracy that would administer this program. Also, rampant taxpayer fraud could be expected in some sectors of the economy with such a high sales tax rate (23% on top of state sales taxes), and repeal of the 16th Amendment is very unlikely.
If former Arkansas Governor Mike Huckabee decides to run for president in 2016, he will apparently plug the FairTax proposal as he did in 2008. Remarks to the Iowa Freedom Summit, January 2015.
Then there is a new proposal to “sunset” the Internal Revenue Code – e.g., by 12/31/19 per a bill introduced by Rep. Bob Goodlatte (R-VA) - which would provide an excuse for not getting down to business on tax reform in the current session of Congress. Start from scratch on taxes? Why there’s a bipartisan push to sunset the tax code, Kevin Mooney, dailysignal.com, 4/9/15.
For all the facile appeal of the foregoing ideas, we believe that the only realistic path to tax reform is to do the hard work of overhauling the current system. To demonstrate what the resulting product might look like, SAFE has developed a detailed tax reform proposal that we call the SimpleTax. It was designed with the aim of generating overall tax revenue of about 20% of GDP (a bit higher than the average in recent years but hardly high enough to satisfy big government advocates).
We envision a thorough overhaul of the current tax system to make it a vehicle to raise revenue vs. fostering social policy goals. Thus, for the individual income tax: broaden the tax base; repeal tax credits, AMT and most exemptions; eliminate double taxation of corporate income and marriage penalty for 2-earner households, reduce tax rates by 5+ percentage points at all income levels. SAFE SimpleTax proposal, November 2010.
If a serious discussion about tax simplification got started, many other proposals would no doubt be offered for consideration. One of them might be the Rubio-Lee tax plan, which will be discussed in part 4 (“Don’t keep digging”).
2. Don’t demand immediate revenue gains – As previously reported, the president and his party have repeatedly conflated tax reform with tax increases on affluent taxpayers and corporations – partly offset by targeted tax breaks for Americans in lower tax brackets. This thrust was evident, for example, in the president’s most recent budget proposal. The net effect would be to further complicate the tax law, versus making it simpler, fairer and more efficient, and to sludge up rather than boost the US economy. Reverse engineering the president’s budget, 2/9/15 (part D).
Tax reform is a delicate flower under the best of circumstances because the generalized interest of the population in lower tax rates can so easily be outweighed by the specific interests of the taxpayers who would lose the benefit of this, that or the other tax preference. If immediate tax increases are demanded as part of the bargain, the effort to sell tax reform becomes well nigh hopeless.
We believe tax rates are high enough, particularly with all the wasteful government spending that is going on. As for complaints that high earners are not paying their “fair share,” they are already carrying most of the tax burden. Democratic big spenders and their big lie, Donald Lambro, Washington Times, 4/16/15.
Even if structured to be revenue neutral, moreover, tax reform should still boost revenue in due course by promoting economic growth. Happy 2012, and why it’s time to focus on taxes, 1/2/12.
While the collection of taxes is never stimulating, the reformed system should do less collateral damage (compliance and enforcement costs, business uncertainty, perverse favoring or penalizing of certain firms or activities) than the unstable, inordinately complicated system that is currently in effect. Both sides should be happy about this.
Bearing in mind the adage about not “killing the golden goose,” we would think that all concerned should be able to agree that the elimination of tax preferences needs to be fully offset by tax rate cuts.
3. Don’t wait for the “perfect time” – The problem with putting something off until tomorrow is, as the saying goes, that “tomorrow never comes.” A similar principle applies to postponing action on tax reform until after the next elections, because once the dust settles everyone will start thinking about the elections after that.
If a political party or faction favors tax reform and has a reasonable opportunity to develop proposals, they should get to work. Granted, it may be necessary to take and defend positions on controversial issues, but politicians who aren’t willing to do that will never accomplish anything worthwhile.
As a case in point, it was our hope at the start of 2012 that congressional Republicans – which held a solid majority in the House of Representatives – would make tax reform their top priority for the year. Happy 2012, and why it’s time to focus on taxes. 1/2/12
Given the urgency of getting government spending under control, why should fiscal visionaries worry about tax reform? We would suggest three reasons – timeliness, relevance, and politics.
After the president’s State of the Union address, we urged Congress to get serious about tax reform instead of waiting until after the elections to decide what to do about the Bush tax cuts that were scheduled to expire at the end of the year. Letter to all members, 2/1/12.
• Did the White House speechwriters stumble across our “to do” list for Congress (1/16/12 blog entry) and decide to contradict every point in the State of the Union address? Probably not, but they might as well have, because the two messages are irreconcilable.
• Don’t argue about the expiring Bush tax cuts in December; overhaul the tax system now. *** For discussion and references, see SAFE offers DC a “to do” list for 2012 (1/16/12) and SOTU finesses fiscal responsibility (1/30/12).
At the end of February, we acknowledged the difficulties of finding common ground on tax reform but urged that the House take on the project anyway because, after all, what else did it have to do that was more important? House Ways and Means should get moving, 2/27/12.
Here would be the basic steps: (1) review the various tax plans that have been proposed (we would be glad to testify about the SimpleTax); (2) agree on a plan (by majority vote); (3) secure House approval (by majority vote); and (4) transmit the Comprehensive Tax Simplification and Reform Bill of 2012 to the Senate for action by September 1.
Not that we envision the Senate approving such a bill, no matter how brilliantly designed, but – just like the House budget resolution that is understood to be in the works – it would help get the American public engaged in determining the path forward on some crucial issues that have been deferred far too long. If not now, when? If not the members of the present Congress, who?
Our advice was ignored, the Republicans lost the presidential race and suffered reverses in Congressional races, and the “fiscal cliff” negotiations at the end of 2012 resulted in a big tax hike with essentially zero spending cuts. So much for the advantages of “playing it safe.” Budget war grinds on, SAFE newsletter, Winter 2012.
4. Don’t keep digging – As noted earlier, the president’s tax proposals leave a lot to be desired. Not only are they designed to “enhance revenue,” but they would further complicate the tax system, not simplify it. In short, these proposals would continue the feckless approach to tax legislation that has brought the system to its current sorry state. Reverse engineering the president’s budget, 2/9/15 (part D).
•Higher taxes on affluent individuals (hike capital gains rate, end basis step-up for inherited assets, reduce the value of tax deductions, enact the Buffet rule), big financial firms (fee on liabilities), international businesses (14% tax on currently accumulated international earnings and 19% tax on international earnings going forward), and smokers (higher tobacco taxes).
•Pluses and minuses for domestic business operations (cut corporate tax rate, make the R&E tax credit permanent, etc. but also slow tax depreciation, end LIFO accounting, etc.), which might tend to favor US vs. offshore manufacturing.
•Middle class and lower individuals would receive new or enhanced tax breaks, including a higher childcare tax credit that would phase out at a higher income level, a new Earned Income Tax Credit for two-member households, etc.
In one instance after another, SAFE’s SimpleTax proposal would take the tax system in the opposite direction, with the aim of making it simpler, more efficient, and fairer.
•Eliminate most tax preferences, don’t water them down for affluent individuals only, and offset the effect with a reduced (but still progressive) schedule of tax rates. Instead of enacting the Buffett rule, end taxes on dividends and capital gains so as to avoid double taxation of business earnings.
•Cut the corporate tax rate sharply, say to a top rate of 20%, while eliminating a host of special exemptions, deductions and tax credits (other than the foreign tax credit) that are currently in effect. Say goodbye to the R&D tax credit, energy tax credits, the special domestic production deduction to subsidize US-based manufacturing, etc.
•Instead of creating new tax credits for middle class and lower individuals or enhancing credits already on the books, eliminate all of them – with offsetting reductions in the applicable tax rates. Most people would wind up owing at least a little income tax as a result, giving them some incentive to question government spending levels, and no one would get “refunds” for taxes they never paid through the mechanism of “refundable” tax credits.
Lest it seem that we’re picking on the president’s proposals, it should be added that Republicans have also incorporated refundable tax credits, etc. in their legislative proposals. The Rubio-Lee plan would be good for everyone, especially low income earners, Kyle Pomerleau, Tax Foundation, 3/15/15
•Some features of this plan are commendable, e.g., eliminating taxes on dividends and capital gains, reducing the corporate tax rate to 25%, and doing away with most itemized deductions, which mainly benefit affluent taxpayers.
•We cannot subscribe, however, to the proposed expansion of the child tax credit (from $1K to $2.5K per child). Ditto replacing the current standard deduction and personal exemption with a new refundable tax credit. The estimated net effect of these and other changes would be, for example, to increase the after-tax income of the bottom decile (10%) of “taxpayers” by 44.2% - [effectively paying them a big wage supplement instead of allowing their wages to be set by supply and demand].
5. Don’t shoot for piecemeal fixes – When tax provisions are tackled on an isolated basis, it’s hard to balance the equation and ensure a revenue neutral result – as could be done in a broader review.
Consider the current push to eliminate the estate tax (aka death tax), which according to a Joint Committee on Taxation estimate would result in a revenue loss of $269B over 10 years. Assuming the estimate is accurate, how would this loss be offset? And who is to say that the descendants of the affluent departed should receive this benefit? House passes repeal of estate tax, but veto vow makes it dead on arrival, Washington Post, 4/16/15.
SAFE favors repeal of the estate tax, by the way, but our position is based more on practicality than principle. SimpleTax.
Somewhat surprisingly, given the long-running debate about the “death tax,” the amount of federal revenue at stake is “only” about $30B a year gross (surely much less on a net basis). It would make sense, in our opinion, to eliminate federal estate and gift taxes and cede tax jurisdiction in this area to the states.
In other cases, such as the termination of this or that tax preference, the shoe is on the other foot as the proposed action would increase tax revenue without an offsetting reduction. This may have been one of the reasons that Congress gave up on making sense of a large number of expired tax preferences last December – after the president threatened to veto a bipartisan deal that was developing – and (much to our disappointment) temporarily revived all of them. House passes short-term tax cut package, Susan Ferrechio, Washington Examiner, 12/3/14.
Another example is the current talk about business tax reform, which is imagined to be more doable than individual tax reform. Tax reform his roadblock: small businesses, Joseph Lawler, Washington Examiner, 4/17/15.
President Obama and key congressional Republican leaders have said for weeks that they are working on [a] deal to reform business taxes that would lower rates and broaden the tax base by eliminating credits and deductions. The two sides are too far apart on individual tax rates for an overall deal, but Republicans have said they could settle for reforming the business side now and aim for the individual side in 2017.
Given the nature of the president’s business tax proposals, which were long on revenue enhancement and short on real reform (the only truly positive point was a modest reduction in the corporate tax rate), we fail to see a basis for expecting a constructive compromise.
Moreover, there is no way to tackle some major business tax problems – notably double taxation of business income and the growing realization of income through entities other than traditional corporations, e.g., partnerships and LLC corporations - without considering the applicable individual as well as corporate tax provisions. No wonder many small business people have been underwhelmed by the plans that are underfoot. Ibid.
On Monday, the Wisconsin Republican [Rep. Paul Ryan] and his Senate counterpart, Republican Orrin Hatch of Utah, sent a letter to small business groups asking for ideas on how to accommodate pass-throughs.
In their letter, the Coalition for Fair Effective Tax Rates responded that "[a]s a practical reality no combination of credits, deductions or exclusions will bring about tax rate parity and produce a fair, simple, transparent and pro-growth tax code." Furthermore, the group accused Ryan and Hatch of endorsing the "president's approach to tax reform," namely working on business-only tax reform, which it said was "contrary to the aim of true tax reform."
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Summing up, we think that the House Ways and Means Committee should get to work on a comprehensive tax reform proposal now, not after the next election. And forget a flat tax, FairTax or sunset plan, because these “silver bullet” proposals are simply not practical. Also reject the notion that revenue must be raised up front; it would follow in due course if real tax reform was enacted.
A serious tax reform effort might conceivably lead to constructive legislation in this session of Congress. But even if it didn’t, the effort would not be wasted because proponents of real reform would be developing a credible proposal that could be run by the voters in 2016.