18 October 2005

More On Proposed Tax Reforms

The President's Advisory Commission on Federal Tax Reform has released another large batch of proposals for the tax code that belies earlier indicatations that the proposed changes would be relatively modest.

The panel would shrink the number of income tax rates from six to four and put 75 percent of individuals and families in the bottom 15 percent tax bracket.

Whether this is good or bad depends entirely on what the rates happen to be. There is certainly nothing fundamentally good or bad about four rates v. six rates.

The AMT would be abolished.

Generally a good thing. A dual tax system is very complex and the AMT didn't work very well, although it had good distributional effects.

Individuals would not pay tax on roughly three-quarters of the capital gains on corporate stock.

The preference for qualified dividends would also be retained.

This is a fundamentally bad idea, but no worse than the status quo.

"[T]he federal tax deduction for state and local taxes paid would disappear."

While this slightly favors low tax red states over high tax blue states, the deduction closely tracks income, so if it is accompanied by rate reduction, it isn't necessary huge in its implications. It also does signficantly simplify the tax system.

Myriad personal and family tax breaks would be replaced with one family credit. Income tests designed to keep most current tax breaks within the middle class would be eliminated, letting wealthier individuals and families benefit.

This also isn't necessarily bad, although the devil is in the details.

Benefits and savings accounts for retirement, health and education would be eliminated in favor of three savings accounts, all funded with taxed income that would be allowed to grow and be withdrawn tax free.

One account would let workers save for retirement through their employers. Taxpayers could also put $10,000 every year into each of two accounts, one for retirement and the other for health, education and home-buying expenses. Low income taxpayers could get a savers credit worth up to $500. . . .

Setting up a group of three Roth IRA type accounts, one for employer retirement savings, one for personal retirement savings, and one for everything else, is essentially the flat tax idea of eliminating all taxation of investment income for all but the very rich. In practice, we've been moving in that direction for a long time, but it isn't a good direction as it inappropriately narrows the tax base among a group of people most capable of paying those taxes. The tax code should not favor unearned income over earned income. Also, the transition of existing retirement savings to the new regime could be mind bogglingly complex. The existing retirement savings system is too complex, but it isn't clear that this is the best solution.

One resulting change converts the mortgage interest deduction to a credit, while also limiting the size of eligible mortgages to the area's mortgage limit as set by the Federal Housing Administration.

This has the potential to be positive, but may have an undue impact on housing prices, the reliance interests of existing large mortgage holders and in particular relatively moderate income people in very expensive housing markets like Northern California, Boston and New York.

It also caps unlimited deductions for health insurance that businesses provided to workers, setting the tax-free limit at $11,500 for families and $5,000 for individuals -- the size of the benefit provided to members of Congress.

Is this really a problem? Of all the abuses in the tax code, splurging on over expensive health insurance plans is not one that comes up very often. Moving the nation overall to a system that favors large personal health savings accounts accompanied by large deductible health insurance plans tailored to meet the limits, is not wise.

Other fringe benefits for employees, like child care and life insurance, would be taxed.

Some of these add more complexity than they are worth. But, most are also not very costly and many are hard to maintain records sufficient to tax conventionally. Also, the only life insurance benefits that receive significant tax benefits are group life insurance plans up to $50,000 per person.

It retains the earned income tax credit, a benefit designed to lift the working poor out of poverty, but gives workers the option of letting the IRS make that complicated calculation.

So what?

A key change would give businesses more investment incentives by letting them immediately write off the cost of new equipment.

Very bad.

More details are here.

1 comment:

Andrew Oh-Willeke said...

Background on the looming AMT crisis, which is driving the panel's actions can be found here.