Tax Reform

I love the idea of tax reform.  I love the idea of tax simplification even better.  Based on my limited knowledge of tax bills being discussed in Washington, they collectively deliver neither reform nor simplification.  I understand that these goals are not easy to achieve.  What worthwhile goal is?  Tweaking some deductions and lowering some rates is not tax reform, unless you consider exchanging a used white oxford shirt for a new white oxford shirt wardrobe reform.

A big picture look at the tax reform construct reveals:

1. Corporate tax rates are lowered significantly. I think this is probably a good idea because the rates are high compared to corporate rates in other countries.  But it is no panacea.  Companies make few large decisions based solely on tax rates.  Moreover, companies almost never hire more people because taxes are lower; they hire people when the new hires can help the company generate more profits.  Tax rates influence how much profit a company gets to keep, not whether it will be profitable.

Lower tax rates are not reform.  Changing the tax treatment of dividends would be a significant and long overdue reform.  Currently if a company with $10 million in profit pays $5 million in dividends to shareholders, it must pay taxes on the $10,000,000 profit.  That may or may not be fair.  What is certainly unfair is to then tax the shareholders on the $5,000,000 in dividends that they received.  That is double taxation, both the company and its shareholders pay taxes (though at different rates) on the same $5,000,000.  As far as I can tell, no change is contemplated.

2. The estate tax is being eliminated. This is true reform, but it is also virtually meaningless.  Of the 2.6 million people who died in 2013, only 4,700 paid federal estate tax – that’s a bit less than one person out of every 550 who died.  http://www.taxpolicycenter.org/briefing-book/how-many-people-pay-estate-tax

This tax is often derisively called the “death tax,” as if that makes is worse than any other tax.  Taxes are just the way a government pays for the things it does.  The focus of any tax reform should be to ensure that government can pay for its own operations and to make paying taxes easier for the taxpayers.  Lessening the tax burden is a separate issue, though more important.  The best way to lessen the tax burden is to reduce governmental operations.  Our politicians seem incapable of doing that.

The bottom line is that the estate tax doesn’t affect many people and doesn’t raise much money (about $20 billion a year).  Instead of eliminating it, which would allow the mega-rich to avoid taxes on potentially billions of dollars of appreciation,[1] we should raise the floor.  At the current $5,000,000 or so, few family farms need to be sold to pay estate taxes (a common claim among detractors of estate taxes), but to make sure it never happens, let’s raise the floor to $50,000,000.  Then only the truly wealthy would be subject to this tax and it would continue to pay for some minimal level of governmental operations and would undercut opponents who say that tax reform inordinately benefits the wealthy.

3. Deduction tweaking is a mixed bag. The current concept calls for a higher standard deduction but lesser itemized deductions.  Most analysis suggests that the majority of lower and middle class taxpayers will pay less (for a few years[2]), but that some significant minority (primarily those in states with high state and local taxes) will pay more.  There’s really nothing inherently wrong with that – the current system has the opposite effect or did when it was instituted.
4. The reform is going to increase the budget deficit by $1.5 trillion over ten years. Maybe a little less, maybe a little more depending on how the economy does.  Of course, nobody knows the exact number, only that the deficit will be grow from the current $400 billion or so.  And here I thought we wanted the deficit to be decrease.

Tax reform should be budget neutral in concept, it shouldn’t assume a $1 trillion plus hole.  I am constantly amazed at how few Republican politicians are concerned about adding substantially to the deficit when they control the budgetary process.  Oh how they caterwaul when deficit increase while the Democrats are in charge.

In short, this particular version of “tax reform” is not very reformy.  They should call it the tax change bill because they are just making a few changes.  They should also tell POTUS that his billionaire status will be enhanced not reduced by the tax plan.  POTUS seems to think that eliminating the estate tax will cost his family a fortune.  Although we can’t know for sure because he refuses to release his tax returns,[3] it is virtually inconceivable that, even if he pays a bit more annually (which is unlikely), his family is a loser in aggregate.  If he is worth close to $10 billion (as he claims), the elimination of estate taxes will save his family hundreds of millions.

I believe we should engage in serious tax reform that simplifies the tax system and is revenue neutral.  Currently the federal income tax raises approximately $1.7 trillion.  https://www.cbpp.org/research/federal-tax/policy-basics-where-do-federal-tax-revenues-come-from  The total personal income of taxpayers is $16 trillion.  https://www.statista.com/statistics/216756/us-personal-income/   Personal income includes income from all sources:  salary, dividends, interest, pass-through businesses, etc.

I would treat them all the same, income is income. [4]  I would eliminate all personal deductions, all personal exemptions.  ALL OF THEM.  That is reform.  That is simple.  That would allow us to file our taxes on a postcard.

Furthermore, I would ignore all income below some floor, let’s call it $30,000.  A  single taxpayer would have the first $30,000 of income ignored, a married couple the first $60,000.  All income over this level would be taxed in an increasing path until we reached $1.7 trillion in taxes.

I can’t find enough good information that enables me to do the math.[5]  But it’s not complicated.  Think about it this way – the next $10,000 of income for every taxpayer could be taxes at 10%, the next $10,000 at 15%, etc., until we reach the number that income taxes currently raise.  There would be many tax brackets, but they would be based solely on income and would not affect deductions or exemptions or anything else – because there is nothing else.  The top rate might have to be as high as 35%, but we need to average “only” 10% or so to raise $1.7 trillion based on total personal income of $16 trillion.

A simple plan like this would allow people to make decisions based solely on their income, not whether this or that is deductible.  The biggest problem with this plan (other than the fact that it will never happen) is trying to find new jobs for the various tax professionals who would be rendered obsolete.  I would not consider that a tragedy.

[1] Company founders can avoid all tax liability under the new plan by never selling their stock.

[2] Many of the reforms that benefit lower and middle income taxpayers are scheduled to terminate in the next few years.  This is necessary to ensure that the deficit grows only so much.  It’s a game the partisans of the tax plan employ to keep the estimated increase in the deficit below a certain level for political reasons.  They insist that the reforms that terminate will be extended, meaning that the true deficit will be greater than currently estimated.

[3] What is he hiding?  Hasn’t he said something similar about people who didn’t want to disclose something?

[4] I believe the country would support one massive exception – “profits” from the sale of a personal residence should not count as income.  “Profits” is in quotes because most “profits” from the sale of a personal residence are really just inflation.  Most homes do not truly appreciate.

[5] Believe me, I tried.  I have the spreadsheets to prove it.