What Income Tax Reform?
Monday, January 30, 2006
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Last November the President’s Advisory Panel on Federal Tax Reform issued a lengthy report, the result of ten months of work. The report resulted in some immediate debate because it proposed the elimination of some tax deductions, most notably those for state and local taxes and home mortgage interest. But after the initial controversy, the report vanished from the headlines. And most Washington pundits see little chance tax reform will find a place on the political agenda in this election year.
It is a shame really, for the first theme cited by the panel in its summary of findings comes right to the heart of the matter. “We have lost sight”, the panel writes, “of the fact that the fundamental purpose of our tax system is to raise revenues to fund government.”
Over the years, our lawmakers have, in addition to using the tax system to raise money, used it as a tool of social engineering, encouraging some activities and discouraging others. The result is a lengthy and complex system of rules, deductions and credits which few taxpayers understand and most believe is fundamentally unfair.
The President’s Panel was charged with suggesting changes to “make the tax code simpler, fairer, and more conductive to economic growth.” Those changes were not supposed to increase or decrease the amount of revenue raised. The Panel decided meeting the “fairness” mandate required eliminating the AMT, Alternative Minimum Tax, a parallel tax system which disallows deductions for an increasing number of taxpayers. It also decided to provide relief from the so-called “marriage penalty”, which forces many married couples where both earn income to pay more than they would if they were single taxpayers.
To make these changes without reducing the amount of revenue collected, the Panel proposed a limit on home mortgage deductions and the elimination of the deduction for state and local taxes. Howls of pain immediately rose from the housing industry and from taxpayers who live in areas with high housing costs and high state and local taxes.
The critics observed, correctly, that the loss of these deductions falls more on taxpayers living in areas which in general voted for the Democratic candidate in recent Presidential elections. These critics see a political motive in the Panel’s recommendations. Who knows if there is any truth to that? But to be fair you have to acknowledge that the same taxpayers, who tend to have higher salaries to compensate for the higher costs and taxes in their communities, are also the ones most likely to be hit by the AMT. The AMT takes away many more deductions than the Panel’s proposal and could affect as many as 21 million taxpayers in 2006. So these taxpayers are likely to lose their deductions in the years ahead even if the Panel’s recommendations are not adopted.
There are in fact those who believe the AMT, by eliminating most deductions, is actually a more fair system of taxation then the regular method. To understand this you have only to recognize how many of the lines of the tax form do in fact give some taxpayers a benefit, while denying it to others.
Right at the beginning we are asked for our marital state; Single; Married filing jointly; Married filing separately; Head of household (with qualifying person); Qualifying widow. Why, if our tax policy is supposed to raise money based on a taxpayer’s income to fund the operations of the government, should any of this matter?
The next section asks about our exemptions, which means us and our dependents. If you enjoy controversy, try discussing these items at a cocktail party. Why do we give a tax advantage to people to have children? Some people chose not to have children. Some can’t. Why do we treat them differently from people who have children? Later on in this year’s 1040 form you’ll find the place for what are now tax credits for people over 65 years of age or with certain disabilities. Why? This is not being cruel or heartless. There is nothing wrong with programs, both private and government, designed to help people in need for whatever reason. But many believe they should be separate programs, not elements of tax policy.
These are not radical thoughts. They are not even new. If you look at the original text of the Constitution, you find in Article I, Section 9, paragraph 4, “No Capitation, or other direct, Tax shall be laid, unless in Proportion to the Census….” The founding fathers foresaw these problems and opted for taxation, if necessary, applied equally to all. That meant no deductions available only to certain groups of taxpayers. It also meant a uniform flat tax rate. To allow our smorgasbord of deductions and our progressive tax rate system, a Constitutional Amendment was necessary. The 16th Amendment, ratified in 1913, explicitly overrode the framers’ original ideas on taxes.
It might not be a bad idea to revisit the original doctrine. Or at least to consider seriously the report of the President’s panel. Unfortunately, this report seems to have been treated as so many reports before it (see, for example, Social Security Reform: Answers to Key Questions, from the Government Accountability Office); Received, distributed, and forgotten.
