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My Thoughts on “The Mother of All Tax Reforms”

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Representative Charles Rangel (D-NY), Chairman of the House’s Ways and Means Committee, unveiled a huge $1 trillion tax cut bill. It’s a bill designed to get everyone talking about it, rather than skirting the issues, though anyone thinking the House will pass it is likely misguided. I read CNN’s overview of it and wanted to share some of my thoughts with you all (and hope you do the same with all of us).

Decrease: Action! Action! AMT Repealed!

The bill would repeal the alternative minimum tax, rather than patch it for another year, and this is the marquee headline of the bill. I personally think a full repeal is foolish, why not adjust it and then index the dollar amounts with inflation? The idea was to stop the wealthy from taking unfair tax breaks, which is something I think should still happen, so why repeal it entirely when you can help the middle class while still keeping with the spirit of AMT?

Ultimately the goal of the bill seems to be to get discussion going on the AMT, so what better way than to just axe it? Most experts believe that another one-year patch will be put on the AMT to help the estimate 800 billion people likely to be affected by it (yes, 800 billion is a totally made up figure, but that number doesn’t actually matter unless you’re one of them!). It’s like putting a band-aid on an infected cut; it’s nice that you’re doing something, but let’s fix it instead of putting it off.

Decrease: Higher Standard Deduction

An increase in the standard deduction of $850 for joint filers and $425 for single filers, which, in theory, actually helps the affluent more than it helps the middle and lower classes. In theory, if you are in a higher tax bracket, you’re taxed at a higher rate. Thus, by increasing the standard deduction, you actually decrease the tax on a higher income earning person. Now, in practice this idea will help the lower income folks because they are more likely to take the standard deduction. As the standard deduction increases, the idea that buying a home is better, for the tax benefits, will become less and less clear.

Decrease: Easier Child Tax Credits

Without getting into the muck of this particular proposal, I think anything that allows more tax credits for families with children is a good thing. With the rising cost of college, two income families, and other children related items, I think we need to be fostering an environment in which children of all economic classes are able to flourish. Now, this puts the onus on the parents to actually spend that money on the children, which may or may not happen.

Increase: 4% Surcharge, $200k+ incomes

And the warm fuzzies end as we get into the part where the reform talks about paying for the first three tax decreases… The idea with this particular piece is that married with $200k+ in AGI and singles with $150k+ in AGI would have a 4% surcharge on the sum above that limit added onto their taxes. For those over half a million, it’s a 4.6% surcharge. This, in combination with a repeal of the AMT, would theoretically result in lower taxes for those making less than half a million.

Everything Else

That ends the provisions that most directly affects most of us, the rest include additional taxes on fund managers and businesses that will impact us indirectly. Anytime you tax businesses, it has the potential to stifle growth (duh! less money on investment) but I think that’s in part fueled by how people, businesses included, don’t like to be taxed more. However, if you look at the tax cuts, they’re really just closing loopholes like accounting magic (valuation of inventories would be affected), corporate tax break loopholes, and empower the IRS to penalize companies dabbling in chicanery. In fact, the bill actually proposes to reduce the top corporate tax rate from 35% to 30.5%.

Summary

Other than the AMT, this bill doesn’t really do much for me from the perspective of real change. So you tweak a few things here, tweak a few things there, why not just clean up the whole million page IRS code and make things easier on everyone? I think every time I see one of these “mother of all tax reform” announcements, I think about how simple life would be if we had a flat ax or consumption based tax. :)

What are you thoughts? Fire away!

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20 Responses to “My Thoughts on “The Mother of All Tax Reforms””

  1. kitty says:

    “Increase: 4% Surcharge, $200k+ incomes”
    This would hit a lot of people in expensive areas like California, lower NY State, Connecticut, NYC, Boston. 200K for a family in places where you cannot buy a Handyman Delight for under 500K doesn’t make you rich.

    I’d agree with modifying AMT – adjusting for inflation and fixing a lot of provisions that aren’t loopholes for rich. For example, state income taxes isn’t a loophole for rich, it hits middle class a lot more than it hits rich. Same about exemptions for children. I’d vote for removing these provisions from AMT and adjusting it for inflation. Also use a less broader definition of “rich” -a family earning 200K a year could be a couple of engineers who can loose everything during layoffs. Or someone earning 50K who happened to have capital gains one year.

  2. Michael says:

    There is only 6.5 Billion people on planet earth… I assume you meant million but I also assume that Rangel said billion.

    “Most experts believe that another one-year patch will be put on the AMT to help the estimate 800 billion people likely to be affected by it (yes, 800 billion is a totally made up figure, but that number doesn’t actually matter unless you’re one of them!).”

  3. JACK says:

    I’m sorry, but this is not a tax cut bill.

    Taxes are only truly cut when accompanied by spending decreases. This is a redistribution bill. It’s a redistribution of yet more of the tax burden onto the wealthy for no reason other than that they are wealthy and it plays into the downright nasty attitude that’s developed in this country of pitting people against each other on the basis of class. As long as taxpayers are busy trying to shift the tax burden to someone else, the politicians are free to keep spending and not implement true reform. Basically, it’s a “support this and I’ll sc$%^ your neighbor, not you!” argument. I hate this approach.

    The second way it is a redistribution bill is it is a redistribution from the next generation to this one. Because that’s who will pay for the debt this takes. We want it all, but we don’t want to pay for it. Soaking those with “high incomes” isn’t enough; we’ll soak our kids’ kids, too. Heck, it’s easier; they can’t speak yet!

    I’m glad you mentioned (unlike many) how this bill lowers corporate taxes while increasing individual taxes. That’s a scandalous thing to me, as the tax code is filled with far more loopholes and dodges on that side of the equation than the individual’s side.

  4. jim says:

    Michael: I meant 800 billion more as a joke (since there aren’t that many people) and I was too lazy to look up the estimated number of people affected by AMT. I wasn’t very clear on that.

    Jack: You’re absolutely right, this is a tax redistribution bill.

  5. paidtwice says:

    The whole tax credit for buying a home thing already doesn’t fly for us, because the interest we pay over a year is less than the standard deduction, so now we’ll just get a higher standard deduction. Yay for us?

  6. Posco says:

    Life would NOT be simple with a consumption tax. People would want to make a consumption tax not be regressive with respect to income. (http://en.wikipedia.org/wiki/Regressive_tax) That means a bunch of exceptions in the consumption tax code for how to tax things or amounts of things that you buy.

  7. Lord says:

    The AMT repeal combined with a surcharge is to simplify taxes, which it does to a point. One of the problems I see is in lowering corp taxes below individual taxes mean a lot of income would then be sheltered in businesses so high individual marginal rates such as the surcharge would end up mythical.

  8. Shadox says:

    I also have an issue with the surcharge on $200K or more in AGI. I live in Silicon Valley and here $200K doesn’t get you very far. Sure, it’s a lot of money but the cost of living is dramatically higher here.

    Also, a flat tax would be extremely regressive, as the lower income folks spend a disproportionate portion of their income rather than saving it.

  9. Joel says:

    1- A higher standard deduction does decrease taxes for higher earners, because higher earners rarely if ever take the standard deduction. Virtually anyone who owns a home itemizes their deductions, and how many really high earners rent?

    2- Consumption taxes as they currently operate are regressive. However, to see a consumption tax plan that’s not regressive, go to FairTax.org. They provide a “prebate” that would cover the sales tax on all spending up to the poverty line, so that most if not all poor and low wage families would effectively pay no taxes. A consumption tax also eliminates the vast majority of tax shelters because when you spend, you’re taxed, and it’s a lot easier to hide your income than hide your spending!

  10. dong says:

    The problem with the AMT is that it’s effectively been a way for politicians without ever having to raise taxes. The fact is many of the deductions that the AMT were meant to guard against do no exist anymore because of the reforms in 83. There’s no question that we need tax reform. Whenever the tax law gets more more complicated with special deductions here and there, the public good is not served.

  11. There is no reasonable equity of distribution under the current INCOME tax system. What’s more, the Tax Code has become a “tinkerer’s paradise” for 53% of the lobbyists who game it in Washington DC. It’s a lucrative business, and the U.S. TAXPAYER pays for ALL of it in higher prices (i.e., a hidden tax which is incomprehensible to the average working person).

    Prices after FairTax passage would look similar to prices before FairTax – not “30% higher” as opponents contend – competition would see to it. So, the FairTax rate (figured as an income-tax-rate-non-comparative, sales tax) on new items would be 29.85% (on the new, reduced cost of items because business isn’t taxed under FairTax – thus lowering retail prices by 20% to 30%), or 23% of the “tax inclusive” price tag – this is the way INCOME TAX is figured (parts of the total dollar).

    The effective tax rate percentages, that different income groups would pay under the FairTax, are calculated by crediting the monthly “prebate” (advance rebate of projected tax on necessities) against total monthly spending of citizen families (1 member and greater, Dept. of HHS poverty-level data; a single person receiving ~$200/mo, a family of four, ~$500/mo, in addition to working earners receiving paychecks with no Federal deductions) Prof.’s Kotlikoff and Rapson (10/06) concluded,

    “…the FairTax imposes much lower average taxes on working-age households than does the current system. The FairTax broadens the tax base from what is now primarily a system of labor income taxation to a system that taxes, albeit indirectly, both labor income and existing wealth. By including existing wealth in the effective tax base, much of which is owned by rich and middle-class elderly households, the FairTax is able to tax labor income at a lower effective rate and, thereby, lower the average lifetime tax rates facing working-age Americans.

    “Consider, as an example, a single household age 30 earning $50,000. The household’s average tax rate under the current system is 21.1 percent. It’s 13.5 percent under the FairTax. Since the FairTax would preserve the purchasing power of Social Security benefits and also provide a tax rebate, older low-income workers who will live primarily or exclusively on Social Security would be better off. As an example, the average remaining lifetime tax rate for an age 60 married couple with $20,000 of earnings falls from its current value of 7.2 percent to -11.0 percent under the FairTax. As another example, compare the current 24.0 percent remaining lifetime average tax rate of a married age 45 couple with $100,000 in earnings to the 14.7 percent rate that arises under the FairTax.”

    Further, per Jokischa and Kotlikoff (circa 2006?)

    “…once one moves to generations postdating the baby boomers there are positive welfare gains for all income groups in each cohort. Under a 23 percent FairTax policy, the poorest members of the generation born in 1990 enjoy a 13.5 percent welfare gain. Their middle-class and rich contemporaries experience 5 and 2 percent welfare gains, respectively. The welfare gains are largest for future generations. Take the cohort born in 2030. The poorest members of this cohort enjoy a huge 26 percent improvement in their well-being. For middle class members of this birth group, there’s a 12 percent welfare gain. And for the richest members of the group, the gain is 5 percent.”

    It’s well past time to scrap the tax code and pay for government the way that America’s working men and women are paid – when something is sold.

    (Permission is granted to reproduce in whole or part. – Ian)

  12. Minimum Wage says:

    The FairTax redistributes income from renters to homeowners because homeowners can spend without paying tax.

  13. Minimum Wage says:

    Also, as many conservatives point out in other contexts, government Consumer Expenditure Survey data indicate that many of the “poor” spend considerably more than an income at the poverty level would allow – placing them on the hook for a nontrivial chunk of FairTax. (They may be getting financial help from family, boyfriends, under-the-table employment, etc.)

    For this reason and for the general reason that the government definition of poverty is greatly flawed, poor Americans won’t really get much if any help under the FairTax. Rents certainly won’t go down – and may well go up – when the current tax benefits of owning rental property disappear.

  14. Hank Van Gieson says:

    The notion that under the Fairtax, prices will remain about the same is just plain nonsense. The 20% -30% pretax cost reduction being talked about includes employee payroll and income tax withholding which won’t be available for cost reductions due to fairness and contractual reasons. The best we can hope for is a 10% pretax cost reduction by eliminating employer income tax, compliance costs, and employer share of payroll taxes (7.65%). This will cause a 17% after tax price increase, (1.00 x .9 x 1.3 = 1.17). And that assumes that businesses apply the entire 10% cost reduction to price reductions rather than business expansion, shareholder payments, employee pay increases, increased profit margins, etc. etc. Prices are going up! The real question is whether or not purchasing power goes up enough to offset price increases due to the prebate and increased take home pay. Stay tuned!

  15. Andrea says:

    Joel has the right idea; I believe the Fair Tax is the way to go. Hank, if we transition over to a fair tax then any and all income taxes would be set to zero, therefore no income taxes, no “corporate taxes”, no social security tax, no AMT, no Medicare tax, etc. the only taxes we would pay would be on items we purchase. You clearly have not done your research concerning what the Fair Tax philosophy is all about. Go to FairTax.org or pick up Neal Bortz’s book discussing this exact topic (The Fair Tax Book, Saying Goodbye to the Income Tax and the IRS). He presents a very clear and concise way. I’m not saying that the Fair Tax is 100% perfect and there are not issues with it, but I am saying that it is 100x better than our current system.

  16. Hank Van Gieson says:

    Andrea, having been involved with the Fairtax for over three years, I’ll put my knowlege and understanding of the details of HR25 up against anyone. My post simply rebutted the erroneous statement that prices “would remain about the same”. Can’t happen!!! If you or anyone else still believes that old Fairtax myth, please explain to me just why you believe prices won’t increase. Maybe we both can learn something?

  17. Bronson says:

    A simple point to understand is the FairTax simply moves taxation from the front of your income to the end of your consumption. An example is rent. Rent is taxed today. To have $500 available to pay rent today you must earn $653 in the lowest marginal tax bracket (15% income tax plus 7.65% payroll tax). This expense is not deductible. If the income earned today and used to purchase some good or service is taxable and not deductible, it is the same as taxing the purchase of that good or service.

    Under the FairTax, if you earn $654, you will get to keep it all. The $500 rental payment will now become $650. You are no worse off. The landlord’s expenses will go down. They are not disadvantaged in anyway. The purchase of the property would be considered a business expense and not taxable. Their other expenses for maintenance, insurance, etc are considered business input expenses and not taxable. The seller of the materials they need to buy for that maintenance, the insurance companies selling protection services will also not be taxed on their inputs. Their income from rents will not be taxable. They will simply pay taxes at the retail level like everyone else. All this allows lower prices to be passed through to the renters. Whether lower prices will be passed through depend on supply and demand, just like currently. But even if prices didn’t drop at all, most Americans will be better off. Purchasing power definitely goes up by the increase in take home pay with or without pretax price reductions and now the citizen will be much more in control of their own burdens.

    I realize that the standard deduction/personal exemption result in no net taxes for some, but the prebate under the FairTax accomplishes the same thing and it is larger at every family size…so we are concerned with the margins, not the first dollar.

    I’m not sure if Joel’s comment was meant as it sounded, but to clarify, most home owners today do not itemize. The percent of Americans who itemize is around 34%. Those wil claim the home mortgage interest deduction is 27% and about 68% own their home…so a little less than 40% of home owners itemize their interest. Almost none of these will be the poor or the middle class because when you itemize, you must give up a $10,700 standard deduction (married filing jointly). If your total interest paid plus any other deduction aren’t at least that amount, you won’t itemize. (Based on interest alone, your monthly interest payment would need to be almost $900. How many poor or lower middle class can afford a $1,000 monthly house payment).

    Even for those who itemize, this is not a great benefit. For example, it my total interest deductions were $13,000 for the year, at the same time I claim this deduction I give up another $10,700 deduction (the standard deduction) so my net benefit is only equal to the difference of $2,300 in deductions. Additionally, it is ONLY deductible for purposes of INCOME taxes, not for payroll taxes so I’m still paying 7.65% on the entire payment.

    Under the FairTax, NONE of the base interest is taxable and that applies to 100% of Americans, the poor included. There is nothing to give up and the tax free status applies to the entire tax. The principal is only taxed on a new home so for the poor and middle class, home ownership becomes much more possible. Add to this the fact that savings will not be taxed which helps Americans save for a down payment quicker and the fact that interest costs are projected to decline by 25% making payments less expensive and you have a recipe for many more homeowners.

    A final note, I have several low income clients who I help with cash flow issues. Many times an increase in income is turned down, not because they are lazy, but because an increase in income is subject to new taxes AND costs them in lost EITC as well. When adding these together, their effective marginal tax rate on new income sometimes goes over 50%. they are simply unwilling to work longer hours or harder for less than half their money. Under the FairTax, every extra hour of work or harder effort can be rewarded with 100% of its value. They will determine how it is treated for tax purposes by their own choices, but we will trully be rewarding hard work and savings, the two things we tell most Americans they should do.

  18. As best I can determine, from reading The FairTax Book and other papers, the following basic benefit features ensue with enactment of the Act (HR 25):

    For INDIVIDUALS:
    • No more tax on income – make as much as you wish
    • You receive your full paycheck – no more deductions
    • You pay the tax when you buy “at retail” – not “used”
    • No more double taxation (e.g. like on current Capital Gains)
    • Reduction of “pre-FairTaxed” retail prices by 20%-30%
    • Adding back 29.9% FairTax maintains current price levels
    • FairTax would constitute 23% portion of new prices
    • Every household receives a monthly check, or “pre-bate”
    • “Prebate” is “advance payback” for taxes payable on monthly consumption to poverty level
    • FairTax’s “prebate” ensures progressivity, poverty protection
    • Finally, citizens are knowledgeable of what their tax IS
    • Elimination of “parasitic” Income Tax industry
    • NO MORE IRS. NO MORE FILING OF TAX RETURNS by individuals
    • Those possessing illicit forms of income will ALSO pay the FairTax
    • Households have more disposable income to purchase goods
    • Savings is bolstered with reduction of interest rates

    For BUSINESSES:
    • Corporate income and payroll taxes revoked under FairTax
    • Business compensated for collecting tax at “cash register”
    • No more tax-related lawyers, lobbyists on company payrolls
    • No more embedded (hidden) income/payroll taxes in prices
    • Reduced costs. Competition – not tax policy – drives prices
    • Off-shore “tax haven” headquarters can now return to U.S
    • No more “favors” from politicians at expense of taxpayers
    • Resources go to R&D and study of competition – not taxes
    • Marketplace distortions eliminated for fair competition
    • US exports increase their share of foreign markets

    For the COUNTRY:
    • 7% – 13% economic growth projected in the first year of the FairTax
    • Jobs return to the U.S.
    • Foreign corporations “set up shop” in the U.S.
    • Tax system trends are corrected to “enlarge the pie”
    • Larger economic “pie,” means thinner tax rate “slices”
    • Initial 23% portion of price is pressured downward as “pie” increases
    • No more “closed door” tax deals by politicians and business
    • FairTax sets new global standard. Other countries will follow

    Add to that the operational structure of the FairTax,

    • SIMPLE, easy to understand
    • EFFICIENT, inexpensive to comply with and doesn’t cause less-than-optimal business decisions for tax minimization purposes
    • FAIR, loophole free and everyone pays their share
    • LOW TAX RATE, achieved by broad base with no exclusions
    • PREDICTABLE, doesn’t change, so financial planning is possible
    • UNINTRUSIVE, doesn’t intrude into our personal affairs or limit our liberty
    • VISIBLE, not hidden from the public in tax-inflated prices or otherwise
    • PRODUCTIVE, rewards, rather than penalizes, work and productivity

    and it makes a compelling case to eliminate an average 50-hr/year requirement to file a tax return, and the placement of (non-business-owner) American families at risk for audits, interest, penalties, legal expense, even confiscation of property. (And, for those who do own a business, compliance would be much simpler and less expensive because the Act does not have a code that educes the bartering of tax favors by politicians and special interests, pitting sectors and socio-economic classes against each other.)

    But this concept requires advocacy and money to succeed because, like Huckabee recently said at the end of an interview by a skeptical Cavuto at Fox News, “…the people [will have to] sell it to the Congress.”

  19. Matt Lykken says:

    It seems like nobody in Washington is interested in actual reform, in the sense of changes that would simultaneously do a lot do revitalize the fading American economy and also shift the benefits of the economy back down the scale to the regular middle class people who haven’t seen real income growth for the last 30 years. Out of general disgust with this situation, a couple of colleagues and I – all corporate tax lawyers with experience in how corporations actually respond to incentives – have assembled such a proposal. Rather than work through it in this space, I recommend a visit to http://www.sharedeconomicgrowth.com. The site goes into some detail as to why people should be much more worried about the future than they currently are, and how a pretty simple reform could go far to reverse our currently self-destructive policies. I was just in Shanghai and Delhi in the last week, and seeing again first hand what is happening over there reinforced my sense of urgency to get Americans to wake up and stop shooting ourselves in the foot before it is too late

  20. Matt Lykken says:

    Confessions of a Job Exporter
    Say you owned the corner store and needed to hire one employee. Say further that there was a federal law providing that if you hired an American citizen for that position, you would be subject to a fine equal to 35% of your income. If you said, “OK, if that’s the law then I will hire a non-citizen”, would you therefore be evil? Or would you be entirely justified in saying “If society wants me to hire an American, then they should change that law and not fine me for doing it”? The U.S. government does impose such a law, and multinational corporations face the shopkeeper’s dilemma every day. That law should be changed

    I am one of the people who decides to locate jobs outside of the U.S. Specifically, I am the head of tax for a U.S. multinational. It is my job to advise that high value manufacturing and research should, from a tax point of view, be located outside of this country. I advise that it is better to invest cash in foreign operations than in American ones. If the recent tax proposal of House Ways and Means Committee Chairman Rangel becomes law, I will advise that good administrative jobs should be moved out of the U.S. I don’t like giving that advice, but under current law that’s what the numbers dictate. I want to change that.

    Of course tax isn’t the only thing that governs the decision on where to put operations. My company has a set of activities that we can afford to keep in the U.S. out of loyalty, but if we did too much of that we’d be acquired by another (probably foreign) company. For the rest of the operations, it’s just math – add up relative labor and transportation costs and the cost of materials, figure in tax, and that tells you where to locate, excluding places with homicidal or corrupt governments. For the highest tech, highest profit operations, though – the ones that involve the best jobs – tax becomes dominant.

    U.S. law currently provides that most income earned abroad is only taxed by the U.S. when you bring the cash home. So, if you make $100 in America you only keep $65 after the U.S. 35% corporate tax, but you keep the full $100 if you earn it in the Dominican Republic. When you reinvest that $100 of D.R. cash you can use the full $100 if you invest abroad, but only $65 if you invest in America, due to the U.S. tax bite. So you invest in new foreign operations, not American ones.

    Changing the law to tax the D.R. operations currently would not work. America is not the only economy that counts any more, and most countries do not tax foreign earnings at all. If the U.S. immediately taxed foreign earnings, our companies would get acquired or crushed by competitors, and we’d just lose our headquarters jobs. Like it or not, it is a global economy now, and this country does not control it.

    But there is a simple solution that works. Give corporations a deduction for dividends they pay, and make up the tax revenue by getting rid of special rates for capital gains and by imposing a 7½% tax on individual income over $500,000 a year, which is all it takes to be revenue neutral. That would make the U.S. the best location in the world for high value operations. It would restore our economy and give middle class workers market power.

    There are plenty of proposals circulating for mostly hokey ways to stimulate our weak economy. The American people need to demand a real, long term solution. Change the rules so that I can tell my employer to put all the best jobs here.

    Matt Lykken is a tax attorney and is Director of SharedEconomicGrowth.org. Details of the proposal can be found at http://www.sharedeconomicgrowth.org .


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