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Sunday, November 8, 2015

10th Anniversary of Bush Tax Reform Report

In January 2005, President Bush created his Advisory Panel on Federal Tax Reform. It was tasked to examine the tax system and propose simplified options that were revenue neutral, pro-growth and internationally competitive. One option was to be a consumption tax. The report was due and was issued on November 1, 2005.

The panel held public hearings, reviewed lots of data and studies and suggested reforms. One of their initial findings was the high cost of tax system complexity which they estimated to be $140 billion per year. Per the panel:

"To put this amount in perspective, it is roughly the same as giving $1,000 to every family in America or the amount of money needed to fund all of the following: the Department of Homeland Security, the State Department, NASA, HUD, the EPA, the Department of Transportation, the United States Congress, our Federal courts, and all foreign aid."

I think this type of information needs to be better publicized.  Most individuals will tolerate complexity if it gets them a deduction. But, they are not usually considering the cost to them and the aggregate cost to all taxpayers and the IRS of the provision. They are often not thinking that perhaps the deduction can be replaced with a higher standard deduction amount at no additional complexity cost.

I like the report because I think the panel did a great job getting at the problems with our federal tax system in terms of complexity, inequity, inefficiencies and lack of accountability and transparency. Unfortunately, the report really died upon issuance in November 2005 most likely because they proposed improving the mortgage interest deduction contrary to what "conventional wisdom" says it should be. The panel proposed that the home mortgage interest deduction be replaced with a credit equal to 15% of the interest paid with the debt limited to the average regional home price (about $227,000 to $412,000).

If that is what killed the report before it could get its hearing, I hope things have changed, but I suspect they have not. The panel's proposal would make the credit available to all homeowners with debt rather than only to the 1/3 of individuals who itemize deductions.  Also, as a credit, it is worth the same to everyone (although higher income individuals tend to have bigger mortgages). It likely would also reduce one of the largest tax expenditures in the tax code (about $80 billion per year) and distribute this amount more equitably among taxpayers.

Here is an excerpt of the panel's chart showing some of the changes and how incorporated into their two key proposals:

Source: Executive Summary, page xvii.

I also like Figure 5.5 below showing the effective tax rate on different types of investments. The many tax preferences for housing produces a zero effective tax rate. This highlights another problem with our tax system - it distorts investments leading to over investment in some areas and under investment in other areas. What would the economy look like if we did not over invest in housing (perhaps had fewer expensive homes and more investment in businesses)?

Source: Panel Report, Chapter 5, page 71.
I hope the report is not completely forgotten and will be considered in ongoing discussions on tax reform. It raises some good issues and observations necessary for reform to happen.  We can't keep talking about lowering the rates in a revenue neutral manner without talking about reducing or eliminating the largest tax expenditures, the costs of complexity and the distortions caused by a tax system that causes investment inefficiencies. Reform also needs to recognize the tremendous income gaps we have (relevant in determining just how low the rate can go), and the reality that much of our tax system does not reflect today's ways of living and doing business (the subject of my 21st century taxation website and blog).

What do you think?


Awais Ahmed said...

i like your post.
Income Tax Filing Toronto

Wanda Hanson said...

I have to admit that I do not have any problem with the Bush tax reform. In fact, I benefit from it every year at tax time. I get my $1000 tax credit and my earned income credit too. Even if i barely made any money at work, those two provide me a nice refund each year, despite what Obama has to negatively say about Bush every week.

Wanda Hanson @ Tax-Tiger