There is nothing simple about tax reform. Our current system is a smorgasbord of rate brackets and credits and deductions designed to promote growth, but also benefit special interests and preserve favored incentives. The new tax reform plan from two senators — Democrat Ron Wyden and Republican Judd Gregg — aims to strip the clutter. It could make filing taxes as simple as reviewing a one-pager from the IRS. It would reduce the number of tax brackets from six to three (at 15 percent, 25 percent and 35 percent); eliminate the dreaded Alternative Minimum Tax; triple the standard deduction while killing dozens of exemptions; and significantly reform corporate taxes.
But is it a good idea? I spoke with Roberton Williams, a senior fellow at the Tax Policy Center. Yesterday I published the first part of our chat, about how the dramatically simplified tax system could make filing taxes so easy it could threaten the existence of tax preparers like H&R Block. Today we continue the conversation about the nuts and bolts of a bold new vision for our tax structure:
What’s the single most significant change you see in this plan?
The biggest change is on the individual side, the general
simplification that makes the income tax more understandable. If you go
back to 1986 the last time we did a major tax reform, we had 15 tax
rates and we went down to 3. It brought the rates down a lot, and got
rid of a lot of exemptions for special interests. Lower rates, fewer
rates, broader base.
Over the intervening decades, Congress has added in a lot of special
provisions to complicate the tax code: the child tax credit, credit for
going to school, for saving for retirement. This is mostly because
Congress is doing social programs through the tax program rather than
through the spending side. The Tea Party would be all over you for a
new spending program, but it would love you if you announce a new tax
cut. So take the child tax credit. The government sends you a thousand
dollars for each kid you’ve got. We’ve run it through the tax system so
it looks like a tax cut instead of welfare. But it’s the exact same
thing. To be clear, these are good things to do sometimes! But it’s
made the tax system complicated and people don’t understand what’s
going on.
We know this reform would make our taxes simpler. But how would it actually change what we pay?
One big way it could reduce your tax burden is with a large increase in the standard deduction:
it will be $15,000 for individuals, whereas now it’s around $5000 for singles. That does two things. It reduces taxable
income, so it cuts down your tax bill. And it pushes people away from itemized deductions.
My
guess is that it would cut taxes at the bottom. They would maintain all
the tax credits, child, earned income tax credit, child dependent care.
People at the top: their top rate stays at 35 percent rather than
rising as it would under Obama’s plan. But the bottom 10 percent
bracket is eliminated, so they still have the bottom of their income
taxed at 15 percent. It does look like people
at the bottom are better off, but people in the top might be slightly worse
off.
So this cuts down on itemized deductions. How does that make the system simpler?
It removes complicated deductions. For example, one really big one they
have is getting rid of the deduction for state and local taxes.
How does that deduction work?
Currently, if I pay $1,000 in state taxes and I’m in the 15 percent
federal tax bracket, I can deduct the $1,000 and save $150 of income
tax. Effectively I pay the state $850 and the federal government kicks
in $150 through my tax savings. We could have the same outcome if my
state tax were only $850, I wasn’t allowed to deduct that on my federal
tax return, and the federal government sent the state $150. That’s what
they’re trying to make happen.
The underlying assumption is that I’m willing to pay $850 for state
services but not $1,000. Without the federal tax savings, I’d be an
unhappy taxpayer. But with the deduction, the state can get more
revenue–$1,000–and I’m happy paying only $850 (net of tax savings).
The tax deduction is an indirect form of revenue sharing from the feds
to the states. The proposal would remove the deduction from the income
tax and make the revenue sharing direct.
What kind of deductions and exemptions does the plan keep?
They’re keeping the mortgage interest deduction and the charitable gift
deduction. This is understandable, given the complaints the
administration got last year when it tried to cap charitable
deductions. The two big groups that complained then were the charitable
groups and the real estate industry. They said don’t do this, and
Congress received the idea with cacophonous boos. [Editor: Full list of
deductions in the Wyden-Gregg plan here.]
Does the bill move the tax burden to the consumption side?
There is nothing that I see in the bill to do that. There might be
something that I’m not seeing. It does make sense to move to a VAT.
We’re the only industrialized country in the world that doesn’t have a
VAT. You look at our fiscal situation, and there’s no easy way to cut
spending. So we need revenue. A VAT can be low-rate so it doesn’t
effect behavior much, and broad-based so it collects a lot of money.
The complaint is regressivity. The poor spend every cent they’ve got.
But you can make up for that with a tax credit at the bottom end.
Will this plan be revenue neutral? Will it raise or lose money for the government?
We haven’t done a revenue estimate. The Congressional Research Service
did something for them — but it’s loaded with caveats. It basically
says as a package this would make money relative to current tax law. It
would not make as much as the president’s proposal, which raises taxes
on the wealthy next year.
From the looks of things, the plan mostly cuts taxes for individuals. So where’s the money coming from?
They’re closing loopholes on the corporate tax side: things like not
allowing firms to hold income overseas without paying taxes on it and
then bring it back home, which is called repatriation. This proposes to
tax that money immediately.That that would bring in more revenue. By
bringing more money home you’d have more investment here and less
overseas. Now it makes sense for say Exxon to invest in projects in the
Middle East that have a lower rate of return than here in the US
because they’re deferring their tax liability. Bring those dollars home
and invest in higher return enterprises at home.
Second, it taxes a lot of income not now taxed. There are two big ones
here. It ends the exclusion for Social Security benefits. It would also
include taxes on municipal bonds. This is a big source of wealth for
rich people.
One thing the tax plan does is it cuts the value of inflation from a
corporation’s interest deduction. That’s sound complicated! Walk me
through that.
There are two ways to finance investment. You can sell stock or borrow
money. To sell stock you have a return. These are non-deductible
dividends. But right now firms can deduct the interest they pay on
money they borrowed. It’s cheaper to borrow money than to sell equity,
so corporations do too much borrowing. This law is trying to balance
the incentives here and attract direct investment.
(Flickr/Mat Honan)
