Wednesday, October 12, 2005

Tax Panel Teasers

David Rosenbaum provides an interesting preview of the anticipated November 1 report of the President's tax advisory commission in today's New York Times. He gives us the summary right up front:

President Bush's tax advisory commission indicated on Tuesday that it would not propose replacing the income tax with a national sales tax or a value-added tax, but would recommend limits in the popular tax deductions for mortgage interest and employer-provided health insurance.
To which I say good, good, and really good. I'll take them in order.

No national sales tax or value-added tax. If I were starting a tax system from scratch, I would look to a broad-based tax on consumption rather than income. But I'm not in that position, and the transition from the current system, in which there is deferred income waiting to be taxed, to a consumption-based system in which that income would have no way of being taxed, is too complicated to inflict on ourselves. The best approach now is to keep the income tax, while broadening the definition of income to allow the lowest possible tax rate on that income.

Limiting the home-mortgage deduction. Another fine idea. I wouldn't quibble with a policy like this that is designed to encourage homeownership. (And the White House is genuinely fond of its homeownership talking points.) But making that incentive a deduction rather than a credit and extending it to mortgage amounts that clearly pertain to the margin of "how big a house should I get" rather than "should I own my own house" are bad policy moves. They are not progressive, and they give back tax revenue relative to a pure income tax base that must be made up with higher tax rates elsewhere. So pare them back slowly.

Limit the exclusion of income taken as health insurance premiums from taxable income. I posted about this last December (here, here, and here). The exclusion favors those with high income relative to those with low income, because the latter have lower income tax rates and are less likely to have health insurance. How is that good tax policy?

The common thread in these two items is that look to raise revenue by limiting exceptions to the principle of taxing income that go disproportionately to higher income households. The article mentions the deduction for state and local taxes paid in the same vein. To that, I would suggest the subsidy to saving for college educations through 529 plans as another item that could be pared back.

Why the new focus on ways to raise revenue by broadening the income tax base? According to the article:
At its last meeting, in July, the commission agreed to recommend abolishing the alternative minimum tax for individuals, a step that would cost the federal government $1.2 trillion in lost revenue over 10 years.

The AMT, because it is not fully indexed, will become the default tax system for a growing number of households. Originally conceived as a way to limit the extent that a household with high gross income could reduce its tax bill through use of every exception from a pure income tax (like those mentioned above, and worse), the AMT has a broad base but is not itself a desirable tax system because it allows so few exemptions and deductions. It was designed for extreme cases (particularly in the pre-TRA 86 period when tax shelters were rampant), not for the typical household. Here's a good summary.

What the tax commission is proposing, in essence, is to scrap the AMT as a parallel tax system but to retain some of its elements to improve the tax system that affects most people. Based on the figures shown in the article, they are not quite revenue neutral. But this teaser of a report suggests that the commission has made a heck of an effort.

As for the partisan spin, I expect it to be severe, but I'm not going to pre-judge that either.

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Anonymous said...

What is the tax rate on interest income? Isn't it higher than dividends or capital gains?

It would be interesting to consider some sort of parity in tax rates among dividends, capital gains and interest income.

Currently people that save may be penalized on taxes.

Anonymous said...

I'm a little confused. Doesn't the health-insurance deduction give employers an incentive to offer health insurance? If that's true, wouldn't removing that tax credit eliminate the incentive? Isn't that a bad thing?

Anonymous said...

$300,000 seems pretty low for the interest deduction to be capped. In a lot of markets, particularly on the west coast where I grew up, that's barely the price of entry these days. I'm not against it, per se, but it seems like at that point you might as well go ahead and drop it.

I also don't really mind the AMT going away and the government "losing" $1.2 trillion over the next 10 years. Does that sound like the point to anyone else?

Anonymous said...

The limit on mortgage interest deduction already exists and recent appreciation has made it quite real. A million doesn't go too far these days. It is a little late to be changing this.

Higher income taxes in the blue states already subsidize the red states. Limiting state and local taxes would trigger a tax revolt, but one that hits Washington, not the states.

They would like taxing healthcare. Anything growing that fast can pay for it, and taxing it would mean less spending on it. Individual medical savings accounts would conflict with it, but could be limited to the base level.

Andrew said...

On the health insurance deduction, it does provide the incentive, but it does so in a way that is less effective, in my view, than an alternative based on a tax credit, rather than an exclusion. Please see the earlier posts noted above.

Anonymous said...

What about social security benefits for retired people? What % of benefits are subject to tax for older people? (85%?) Is there room to raise the amount of social security benefits subject to taxation? This might help cover medicare prescription drugs. If tax rates were lowered on interest income, this would benefit older people and offset this.

Anonymous said...

i like tax rate on interest income, cap gains and dividends at 15% for all income tax brackets. To pay for it, the fed govt can put the highest marginal income tax rate at 36, 37 or 38%. This is still lower than during Clinton era.

Savings will increase. This is a big opportunity for the U.S. Savings will increase without interest rates having to go through the roof.

dearieme said...

"Limiting the home-mortgage deduction": in Britain, it was phased out years ago. But we are still exempmt from Capital Gains Tax when we sell our "principal private residence". Are you guys?

Anonymous said...


You can sell a house that was your prinicpal residence for 2 of the preceeding 5 years and pay not tax on the first $250K ($500K if married) of capital gain.

Fat Man said...

First: Even though I live in a red state I pay AMT. All of these discussions of abolishing this that or the other deduction leave me pretty cold. They are just numbers. To me the real issue is my final liability and whether I can pay it.

Second, I want to propose that anyone who raises a distributional argument for or against a tax be required to prove that the tax in question has an actual distributional impact in the real world. We have had an income tax in the US for more than a century, but we have not had much change in income distribution, maybe its time to stop worrying about distributional issues. Not only that but the income tax has over leveraged us to the fortunes of a narrow stratum of the citizenry. In a republic, I think it is desirable that all citizens should participate in the support of the state. Allowing a class to free ride invites only trouble.

Third: I am distressed that they are not considering a VAT. Because it is imposed on imports and rebated on exports, it seems that the US is at a disadvantage in a globalized economy. I am not an economist, but it seems to me that there is a relationship between the globalization of production and the decline of the corporate income tax. Would a VAT change that balance.

Anonymous said...

" The exclusion favors those with high income relative to those with low income, because the latter have lower income tax rates and are less likely to have health insurance."

If I understand "the exclusion", it's the exclusion of all health insurance premiums paid by employers on behalf of their employees. Is that correct? If so, then middle income folks will be hard hit. Most employees don't think of their health insurance as taxable income. They won't be pleased to discover their ignorance.

Most years, coverage decreases while (and because) premiums increase. Once employees learn that they could pay more in taxes for less coverage, they'll be extremely annoyed. I don't see how that little bit of news will escape notice before any change is enacted.

I'm all in favor of doing it, but not for the reasons mentioned. The health insurance exemption doesn't favor high income people over low income people, but employees of large corporations over everyone else--a very arbitrary distinction.

If the plan is to only remove the tax deduction for employers, while still exempting employees, it keeps the weird distinction--but then, employers will be dropping the benefit anyway so it won't matter much.

Insurance companies will presumably lose a lot of business in this case, so it stands to reason they'd start considering individual customers a bit more desirable than they do now.

Anonymous said...

look at countries full of smart yet poor and oppressed people, and do not repeat or duplicate mistakes.

Anonymous said...

The answer: Capping the mortgage tax deduction at $300,000 rather than $1,000,000.

The question: how can we design a tax increase that will cost the wealthy nothing while targeting the middle class in blue states?

Anonymous said...

I think the Tax Panel is offering recommendations that help most Americans; 70% of all income taxes filed are short form (1040A or EZ) taxes. That means the vast majority of Americans don't use tax deductions. The standard deduction works fine for most. The limits on mortgage interest deductions can only help make owning a home more affordable for more people. AND, simpler tax forms means more Americans can prepare and efile their own taxes ... I supose the large tax preparers, like H&R Block and Jackson-Hewitt are lobbying against simpler taxes. Companies like together with IRS E-File are ready to help ALL Americans!