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Wednesday, October 8, 2008

H.R. 1424 - Does it move us into the 21st century?

H.R. 1424, the bill that primarily allows for what many are calling the "$700 billion financial bailout" also includes lots of tax provisions. Most of these provisions were sitting in other tax bills. These provisions extend over 30 tax credits and deductions that were going to expire on 12/31/08 and provide 1-year of relief from AMT for many individuals. This bill was signed into law on 10/3/08 (P.L. 110-343).

Do these tax provisions help move the tax system into the 21st century? Do they simplify the law? Recognize the ways we live and do business today? Will they increase the deficit such that we must rely on future tax increases or high levels of economic growth to pay down the debt and increased interest expense?

I don't think so.

First, the cost of these provisions, which are not "paid for" - there are insufficient tax increases to cover the cost of the provisions. The Joint Committee on Taxation provides the following figures of what the key tax sections of P.L. 110-343 cost over a 10 year period (JCX-78-08), amounts are in millions of dollars: (figures in brackets are reductions in tax collections)
  • Tax provisions related to the Emergency Economic Stablization Act ($3,407)
  • Energy credits and deductions, most are for just 1 or 2 years ($16,934)
  • Keep Section 199 manufacturing deduction for oil companies at 6% rather than 9% $4,906
  • Foreign income from oil change $2,230
  • Require brokers to include basis on 1099 forms $6,670
  • FUTA Surtax extension for 1 year $1,424
  • Excise tax for Oil Spill Liability Trust Fund $1,715
  • AMT relief for many individuals for 2008 ($61,817)
  • AMT minimum tax credit changes ($2,291)
  • Extension of several individual deductions for 1 to 2 years ($11,491)
  • Extension of several business deductions and credits for 1 to 2 years ($36,893)
  • Misc. provisions including 1 year extention of refundable child credit change ($7,580)
  • Other miscellaneous items ($3,334)
  • Disaster relief provisions ($8,813)
  • Tax treatment of offshore nonqualified deferred comp from certain tax indifferent parties $25,161
  • Other $51

Total ($110,404)

So, over the next 10 years, these tax changes will add another $110 billion to the deficit and debt. The amount is likely to be larger because many of the "fixes" - AMT relief, extending temporary provisions in the law - were only changed for one or two years. Of course, future tax bills may find offsets to pay for the tax reductions.

While most of the energy provisions (new and extended credits and deductions to encourage alternative energy or clean energy) have economic justification in that they reward actions that benefit the environment and thus, society, they add complexity to the law given the number of provisions, numerous definitions and special rules that must be followed to obtain the benefit. It would be good to see if these types of incentives could be combined and simplified. For example, we don't have multiple types of credits to encourage R&D - we have one with a fairly broad definition of research.

One interesting provision calls for a "carbon audit" of the tax law to be completed within 2 years. This is "to identify the types of and specific tax provisions that have the largest effects on carbon and other greenhouse gas emissions and to estimate the magnitude of those effects." I've written about this proposal before - here. If the suggestions made in the report are acted upon, this can help modernize our tax laws so that the tax system is working counter to environmental goals.

The continual extension of over 30 temporary deductions and credits needs to be looked at. Each provision should be carefully examined to determine if it is crucial to having a good tax system or not. If "not" - it should be allowed to expire. If it is important - make it permanent so people can rely on it from year to year. Perhaps some of these provisions can be eliminated with an increase in the standard deduction.

AMT fix - my personal view is that we should get rid of the AMT (see 12/07 op ed here). No doubt, that is an expensive change. But the reality is that this tax is raising far more revenue than it was ever expected to raise and from people it was never intended to apply to. It is a non-transparent way to raise revenue. For example, many people know that if you itemize your deductions, you get a deduction for state income taxes. But, the AMT takes that deduction away. It is past time to just disallow or reduce some deductions and credits in order to remove the AMT. If Congress really wants higher income individuals to pay more tax - remove some deductions and/or raise their regular tax rate. Don't make people go through extra calculations and confusion to get more money from them - be more honest.

Last point - tax gap: There was one measure in this bill to help reduce it - requiring brokers to include basis on 1099s. Our budget system and lack of willpower and attention, make addressing the $345 billion per year federal tax gap a low priority. Instead of a comprehensive effort to address the gap, we see piecemeal efforts to address it with the provisions primarily added to offset tax breaks. We don't see attention given to the greatest tax gap problems (such as non-reporting of cash receipts by businesses). I've written on this one before too (here).

So, we'll move into the 111th Congress and a new president in 2009 with a greater debt, greater tax system challenges and still many outdated provisions in our tax system. I think the solution will be base broadening and lowering of tax rates, but it will need to be timed with the expiration of existing low rates that expire after 2010. It will also require helping to educate the public of the tax system challenges (such as the AMT and expiring provisions after 2010), our growing deficit and debt and its costs to use and future generations, entitlement program problems, increasing health care costs, and a tax system that likely is not ideal for today's global economy.

What do you think?

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