Wednesday, December 5, 2012

Nicholas's Pony Tax Reform Plan

While House Republicans tie themselves in knots trying to figure out how to negotiate with a White House that's finally learned how to negotiate, it's worth throwing out some novel ideas on how to bring government revenue in line with its expenses. Whether these ideas are "conservative" or "liberal" is hard to say; in general, the goal is to raise revenue from its current levels to fund a more energetic national government, but there's no a priori commitment to a French- or German-sized welfare state. If the major functions of the government can be provided on 22% of GDP as Warren Buffett seems to think, then that's fine.

Anyway, in the spirit of the Center for American Progress's tax reform whitepaper, here we go!
  • Repeal the Bush tax cuts on high income earners, and lower the threshold for what constitutes "high income". Our current political discourse defines "high income" as $125,000 for individual filers or $250,000 for joint filers, up from $200K when John Kerry ran for President in 2004. Below this number, households are deemed "middle class". This is an extremely expansive definition of "middle class", largely to pacify Democratic-leaning donor constituencies in urban areas like New York, DC, Los Angeles, San Francisco, and Seattle, where the rent is too damn high. The lower bound for this threshold is probably $75,000 for individuals and $150,000 for joint filers, but I'm not picky on this one; $100,000/$200,000 would work just as well.
  • Create a new 45% marginal tax bracket at $1 million. Ronald Reagan's greatest political achievement was to align the interests of the almost-rich, rich, mega-rich, and stupendously rich by putting them all in the same tax bracket. Inequality has increased dramatically since the 1980s, but our tax code hasn't kept up with these social changes.

    A 45% tax rate means that someone living in New York City or San Francisco faces a top marginal rate of somewhere in the 55-60% range, which is about as high as you can go before rich people start making even more serious efforts to minimize their tax costs. The CAP proposal brings back the Clinton-era top rates at 39.6% at $422,000, so maybe that's a good starting point for the new rate. Warren Buffett has suggested a bracket for the mega-rich who earn at least $10 million a year; in that spirit, we could have one rate at $200,000, a 42.5% at $500,000, and a 47.5% at $5 million.

    The number of different tax rates does very little to make the tax code more complex; computing your tax liability once you've computed your adjusted gross income is a single calculation.
  • Eliminate the Alternative Minimum Tax, and instead cap total deductions at 28% of gross income. Originally intended as a way to prevent the rich from using too many deductions, the AMT form has become quite complicated and must now be filled out by a large number of middle-class households, particularly those living in high-tax states like New Jersey, Massachusetts, New York, and California. Every year Congress "patches" the AMT so that only households above some income threshold are affected. It's time for this to end. One way to do so is to repeal the AMT and instead rely on a limitation on deductions & credits to keep the tax liability of high income earners from getting too low.

    The CAP proposal replaces all deductions with an 18% tax credit, and 28% for charitable contributions. In otherwords, instead of a charitable contribution reducing your taxable income, the government simply reduces your tax liability by $0.28 for every $1 of charity. Business expenses or mortgage interest would drop your taxes by $0.18 for every $1. Credits are by and large more progressive than deductions. I'm agnostic as to which of these approaches is preferable, but both serve the same goal of reducing the ability of high income earners to shrink their tax liability through deductions.
  • Harmonize the means-testing phase-outs for all credits and deductions that appear on the 1040. I suppose it would be nice to eliminate these entirely in order to simplify tax filing. But these credits represent a significant chunk of American social policy. The IRS is currently the second largest anti-poverty agency in the Federal government, behind only the Social Security Administration. So doing away with these credits entirely won't fly.

    But we can make tax filing simpler by reducing the number of computations required. The Child Tax Credit, various Education Credits, Residential Energy credits, Retirement Plan Contribution credits, student loan interest deduction, and so forth, all phase out at different income levels. If they all had the same income threshold, it would make it much easier to file taxes. You'd total up all your available deductions and credits, and then calculate your actual deduction/credit amount based on your income.

    We really ought to look at which of these deductions & credits make sense as social policy, as well as which policies could be better served through direct subsidy, because each one makes the tax filing process more onerous than it needs to be.
  • Eliminate the carried interest loophole. This is some shenanigan by which money managers can treat their income as capital gains rather than earned income. It makes no sense. Just get rid of it.

    The CAP proposal also eliminates something they call the "Subchapter S loophole", by which high income earners can skirt out of some Medicare taxes. We should probably get rid of that one too, but I don't know enough about the underlying issue to say anything definitive.
  • Raise the tax on capital gains income to a Clinton-era 20%, or maybe even a Reagan-era 28%. Computing capital gains income is almost an entirely separate form from the rest of tax filing, but once you decide that you're going to tax capital gains, it's not any more complex to assign a different tax rate to capital gains than to ordinary income. The only question then is what's the right economic policy, and there seems to be some evidence that keeping the capital gains rate a hair lower than on earned income is actually desireably.
  • Treat dividend income as ordinary income. Dividend income, on the other hand, doesn't require any special handling. You just take the total of everything on your 1099-DIVs, add it up, and put it wherever the form tells you to. It can be taxed at the capital gains rate or the ordinary income rate. There's no reason to prefer dividend income to earned income.
  • Replace some or all of the payroll tax with a combination of a financial transactions tax and a tax on CO2 emissions. Workers by and large get out what they put in when it comes to the payroll tax, but at the margins the tax does increase the cost of hiring new workers. It would be better if we funded social insurance through things we have to have but don't want to much of. Carbon emissions and excess financial transactions definitely fall into this category.

    Replacing the payroll tax fully with a carbon tax would raise the price of gasoline by about $1.25/gallon. So you could definitely use a combination of carbon and financial transactions taxes to fund social security and (at least partially) Medicare. The end of the payroll tax would likely mean an increase in workers' wages that would more than offset the rising price of gasoline.
Not having access to the CBO, JCT, the Brookings Tax Policy Center, or the wonks at CAP, I have no idea how much revenue this would raise. It's probably more than what Obama proposed during the campaign, but less than what Obama's budget proposes.

There's no reason for wonks to limit themselves to the set of tax proposals that's deemed viable in the current political climate. Think big!


BruceMcF said...

A cut in payroll taxes that come out of contracted pay ~ the half of the payroll tax that is the "employee's contribution" ~ would feed through to higher disposable income.

There's no substantial reason to believe that cutting the half that is levied on top of contracted pay ~ the "employer's contribution" ~ would lead to higher income. Certainly not at and near the minimum wage, which is where the incidence of a gas tax would be the highest.

Nick Beaudrot said...

"There's no substantial reason to believe that cutting the half that is levied on top of contracted pay ~ the "employer's contribution" ~ would lead to higher income. Certainly not at and near the minimum wage, which is where the incidence of a gas tax would be the highest"

I thought the economist consensus is that this all payroll taxes are effectively borne by the employee (this was one of the reasons some centrist and center-left economists backed away from Bill Clinton's health care plan -- the increase in "employer contribution" to payroll taxes would have been borne by workers).

Now, it may take some time, a vibrant labor market, and a political economy that does more to put its thumb on the scale for workers, so, it might not be true today.

Anonymous said...

We're very much on the same page here, Nick - I could have written most of this myself.

A couple of tweaks I'd do, if I were king for a day:

1) I'd cap total deductions at a flat $50,000 in lieu of the AMT.

2) I'd tax cap gains as regular income, but allow the basis to be adjusted for inflation.

That would mean that if you (the generic 'you', not the literal one) had bought some stock for $5000 back in 1972, and sold it for $15,000 now, you'd get to take a loss on it, but that's only fair - in real terms, you really did take a loss on it.

But if someone bought stock for $5000 yesterday and sold it for $15,000 today, it would be taxed at their marginal rate, which it ought to be.

And yeah, finance Social Security with some combination of carbon taxes (or auctioning off cap-and-trade allowances) and a financial transactions tax. These taxes are good on the merits - the best thing to tax is something you want to have less of - and the payroll tax is regressive.