Deciphering Campaign Tax Proposals
Presentation delivered to
Rotary International San Jose Chapter (District
5170) on May 11, 2016.
Thank you for inviting me to
talk about tax policy and reform. As noted in the publicity for today, my goal
is to help you decipher the wide range of tax proposals mentioned in a
presidential campaign and provide some pointers to help raise your tax policy
savviness.
First, are changes even
needed to our federal tax system?
YES. Here are a few
reasons:
- Taxes are too complex. We have multiple definitions for the same term, such as “small business.” We have duplicative rules such as for tax reductions related to children. Over 150 special rules have been added to the federal income tax since the last major reform in 1986.
- Our corporate tax system fails at international competitiveness. We use a worldwide taxation system and double tax corporate earnings, when most of the rest of the world does not. Our statutory rate of 35% is higher than all other industrialized countries.
- Our income tax has inequities in that some things are deductible such as mortgage interest while others are not. Too much spending is buried in our tax system – about $1.1 trillion, which equals the amount of our discretionary spending. For example, we basically spend about $80 billion each year to allow less than 1/3 of filers to deduct mortgage interest. The majority of this subsidy helps taxpayers with $100,000 or more of income. This is inequitable. It’s also more than we spend on low-income housing. We should be examining why all or part of this $80 billion isn’t used instead to increase the standard deduction or lower tax rates, or allow some type of first-time homebuyer subsidy. Also, special tax rules encourage us to invest in one area over others. What is the overall impact to our economy of our tax system that encourages investment in housing over other types of investments?
- Our tax gap is growing. The tax gap means taxes owed but not collected. This is due to both intentional and unintentional errors. The federal income tax gap is about $400 billion per year! Each year about 147 million individual returns are filed. Thus, each of these filer’s share of the tax gap is about $2,700! Reducing the tax gap could allow for lower rates. Lowering the tax gap will require simplifying the system and going after non-filers.
And these are just some of
the federal income tax problems – we also have problems to address in our employment
taxes, gasoline excise taxes and others.
So, yes, tax reform is
needed - so we should be hearing candidates talk about tax reform.
Well, what are we hearing
from candidates that we may need to decipher?
Let me offer two cautions to aid in deciphering.
Caution number one – be aware that campaign tax proposals almost always lack
specificity, making it difficult to critique them. A common reform promoted for the past few
years is to lower the rate and broaden the base - in a revenue neutral manner. To help
understand this, let’s review the basic tax formula: Tax Rate
x Base = tax owed, which is further reduced by tax credits. Simple math tells us that if we make the base
higher and/or eliminate credits, we can lower tax rates and bring in the same
amount of tax revenue. Broadening the
base means cutting back or repealing deductions, exclusions, preferential rates
and tax credits. BUT, details on which of these special tax rules will be
repealed or cut back to allow for lower rates is usually not mentioned. After
all, who wants to campaign on reducing the mortgage interest deduction or
repealing the lifetime learning credit?
But if we aren’t willing to
talk about each of the more than 200 special tax rules that support high tax
rates, we’ll never achieve relevant tax reform. Each special tax rule needs to be examined in
terms of its purpose, whether that purpose is still valid, who benefits,
alternatives, and overall economic effects of each rule.
We really need to ask for
specific details when we hear that someone wants to broaden the base and lower
rates in a revenue neutral manner.
Caution number two – we need to decipher statements about data or ones calling for
definite actions that must be taken. For example, a common data statement in the
last presidential election was that half of individuals don’t pay income
tax. That’s true. What we didn’t hear
and we didn’t seem to ask, was why? Well,
the 50% of individuals who do not pay federal income taxes does include a few
thousand high income individuals with lots of deductions or loss carryovers.
However, this group is mostly comprised of low income individuals. For 2013, for example, 46% of individual
filers had adjusted gross income below $30,000! They pay little or no
federal income tax because their income is too low! Yet, many in this group do pay payroll taxes
of 15.3%, excise taxes and state taxes. We also hear that high income individuals pay
a higher portion of total income taxes than do other income groups. The top 1%
based on income, pay about 1/3 of our federal income taxes. High income
individuals pay a lot of income taxes because they have lots of
income! And the super high income folks pay
a lot of taxes, but their average tax rate might be lower than that of lower
income taxpayers – a situation that Warren Buffett called attention to in a 2011
op ed in the New York Times,
noting that his average tax rate was lower than that of his secretary. Yes, he
pays more taxes, but at a much lower average rate. Also, while we often hear about making changes
for the income group with more than $250,000 of income – which is less than 5%
of filers, this group has a very wide range of income. IRS
data for 2008 showed that the average income for the top 400 individuals was
$220 million! This is mostly capital gains and dividends taxed at lower tax
rates than the rate that applies to wage income. But perhaps our tax system
should not put people with $250K of income in the same group as those with over
$100 million of income or even over $1 million of income. To understand who pays and how much – we need
to be looking at income levels and total taxes, marginal tax rates and average
tax rates. We need to be asking what are appropriate tax brackets and how
progressive we want the rate structure to be – considering the wide range of
income levels among individuals today. That’s
a better topic than why individuals with less than $30,000 are not all paying
federal income taxes.
The IRS stats website has tons of data. The
non-partisan Tax Policy Center has lots of data in user-friendly formats. We
need to use this data more often.
In addition to critically analyzing data
statements, we also need to analyze any statement. For example, what about “abolish the
IRS.” Of course, this statement is often
fully expressed as “abolish the IRS (as we know it)”. The IRS receives over 180 million tax returns
each year and collects over $3 trillion of gross tax revenues. It also audits
about 1% of filers and writes rules to explain the laws congress enacts. We do need a government agency to do this.
Another statement – we need a carbon tax. Perhaps, but ask why? How would it work? If
we are only going to tax fossil fuel emissions, why not just increase the
gasoline excise taxes? What alternatives exist?
We all need to be more critical of tax
data and statements from candidates.
Ok, so my tips for deciphering campaign tax
proposals are to ask for the details of the plans and to apply our critical
thinking skills to tax data and blanket statements that are offered without
reasons.
I’ll spend my remaining time on my promise to
increase our tax policy savviness beyond the points I just offered.
1. Some proposals call for
replacing all or part of our income tax with a consumption tax. Consumption
taxes come in many forms, such as a sales tax, a VAT, a flat tax or a formula
that removes investment income from the tax base. Yes, when you hear “flat tax”
think consumption tax, not income tax. Questions to ask – how to address the harshness
of a consumption on low income taxpayers. Consumption taxes are regressive –
they represent a larger chunk of a low income taxpayer’s income compared to
higher income taxpayers. Also, will a consumption tax produce enough
revenue? If it causes us to reduce
consumption – how will that affect the economy? What would the rate or rates be? Proposals for a national sales tax use a tax-inclusive
rate of 23% – that really means about a 28% rate – and on almost everything you
buy – services, a new home. Also, to
raise the same amount of revenue that we raise today, because high income individuals
don’t spend all of their income, we likely would also need an income tax for
those with over, perhaps $150K of income.
2. It is difficult to lower our
35% corporate tax rate in a revenue neutral manner. There just are not enough
special corporate tax deductions and credits to allow, for say, a 25% rate. So,
when someone says they will drop the corporate rate to 15% or 25%, ask how it
will be paid for. The answers you’ll
hear, if any, need further discussion.
One answer might be that we’ll stretch out depreciation and R&D
deductions and get rid of all credits including the research tax credit. Well, does that make us more globally
competitive? Probably not. Also,
stretching out depreciation deductions is just shifting deductions to later
years – it doesn’t raise revenue in the long run, only in the 10-year budget period
used for the revenue measure.
Alternatives to the difficult task of
lowering the corporate tax rate in a revenue neutral manner include getting rid
of double taxation of corporate income. Moving from double taxation to
single taxation of corporate income is called corporate integration. It can be
done in a way that reduces taxes directly for corporations, such as by allowing
a deduction for dividends paid. Senator
Hatch, chair of the Senate Finance Committee, plans to issue a corporate
integration proposal in June. Corporate
integration –a single layer of tax on corporate income, is a not new idea – you
can read proposals on the roughly 8 ways to do this, dating back to at least
the 1970s.
Another alternative to lowering the
corporate rate is to move to some form of a consumption tax along with an
income tax for higher income individuals.
Despite its challenges, don’t plan to see
the topic of a lower corporate tax rate drop off of the agenda. A lower corporate tax rate has bi-partisan
support. President Obama has been
calling for it for a few years. Also,
today, a good portion of the corporate tax is borne by labor, not by investors
- making a lower corporate rate of wider interest. The challenges will be lowering the corporate
rate in a revenue neutral manner and agreeing on the details of how to
do it.
3. A plan that repeals the
Earned Income Tax Credit is a tax increase on low-income workers.
4. A plan that says it
simplifies by reducing the number of tax rates is misleading. Complexity is not
due to the number of rates. It is due to the 250 special rules in our tax
system that don’t all need to be there.
Special tax rules support our high rates, inequities, complexity,
inefficiencies, a high tax gap, and a non-transparent system. The challenge of tax reform is changing the
tax base – what is taxed, not how many tax rates we have.
5. Federal tax reform can have
significant impact to state and local governments. For example, states are
indirect beneficiaries of some federal tax credits such as for low-income
housing or for hiring long-term unemployed individuals. A flat tax requires
governments to pay tax on fringe benefits paid to employees. A consumption tax will make all interest
income tax-exempt requiring state and local governments to pay higher rates on
the bonds they issue.
What should you ask
candidates about their tax reform plans? Here are a few suggestions:
- What is the goal of your plan? Simplification? Greater equity and fairness in the system? International competitiveness? We really can’t evaluate any paln without knowing its purpose and goals.
- Is your proposal revenue neutral? If not, how will reduced or increased revenues be addressed
- Is the plan distributionally neutral? If not, which income groups will pay more or less than today? How much more or less? How does this affect vertical and horizontal equity?
There are some good sources of information available
to help understand our current tax system and proposals for reform …
-
Data from the IRS stats website
and the non-partisan Tax
Policy Center (and their Briefing Book).
-
The Tax
Policy Center and The
Tax Foundation have detailed analysis of the plans of presidential candidates
and their cost.
Taxes are a complex topic
and public understanding of them is low. Thus, candidates can oversimplify, be
vague, and even make incorrect statements. We need to apply critical thinking
and ask for details.
Tax reform is difficult, but
not impossible. It is also necessary.
Thank you. I’d be glad to
take your questions on federal tax reform or even state and local tax reform.
What do you think?
