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Monday, May 19, 2008

Helping the Federal Income Tax Cry Out for Reform

While well-intentioned and needed, a recent bill passed by a tax-writing committee also indicates the need for a serious look at our federal income tax system to see how it can be simplified, made more logical in terms of what we want it to do in addition to raising revenue, and how it can support economic growth. This bill makes it even more obvious that our federal income tax is in need of some type of reform.

On May 15, 2008, the House Ways & Means Committee passed HR 6049 which makes many changes to our federal income tax. Many of these changes are 1 year extenders of provisions that expired at 12/31/07, such as the itemized alternative deduction for sales tax, the deduction for qualified tuition and expenses, and some energy incentives. In total, 33 expired provisions were extended for one more year! That avoids the issue of having to determine if they should be made permanent or if they have served their purpose and are no longer needed. These temporary provisions make tax planning difficult (for example, will the benefit be renewed or should alternatives be pursued by taxpayers).

HR 6049 also includes a few new provisions, such as a temporary above-the-line deduction for real property taxes, limited to $350 ($700 for a joint return). Why? What is the rationale for allowing a deduction for state and local taxes? [For more on this topic, see a short article - Goodbye State Tax Deduction (5/08); perhaps I should have called it "Hello new state tax deductions."]

Some of the funding for HR 6049 comes from a temporary modification in corporate estimated tax payments (a non-permanent source of funding).

These elements of HR 6049 are an indication that it is time for some type of tax reform. Isolated changes, such as the temporary deduction for real property taxes by non-itemizers, should instead be done in the larger context of what type of income tax do we want/need and how do we get there. For example, do we want an income tax wtih a broader base and lower rates? Do we want an income tax with lots of temporary provisions? The presence of so many temporary provisions in the tax system add to its complexity, hinders effective tax planning, and takes time away from serious tax reform discussions. It also perhaps helps those wanting reform to point to a tax law in even greater need of reform!

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