Thursday, November 11, 2010


In “Obama's Debt Panel Releases Three Tax Reform Options” Paul Caron, the TAX PROF, tells us:

The co-chairmen of President Obama's National Commission on Fiscal Responsibility and Reform today released a discussion draft in advance of its final report to be issued on December 1. The report presents three tax reform options:

Option 1: The Zero Plan

* Consolidate the tax code into three individual rates and one corporate rate
* Eliminate the AMT, Pease, and PEP
* Eliminate all $1.1 trillion of tax expenditures
* Dedicate a portion of savings to deficit reduction and apply the rest to reduce all marginal tax rates
* Add back in any desired tax expenditures, and pay for them by increasing one or all of the rates from their zero expenditure low

Option 2: Wyden-Gregg Style Reform Individual Tax Reform

Individual Tax Reform-
* Repeal AMT, PEP, and Pease
* Establish 3 rates – 15%, 25% and 35%
* Triple standard deduction to $30,000 ($15,000 for individuals)
* Repeal state & local tax deduction, cafeteria plans, and miscellaneous itemized deductions
* Limit mortgage deduction to exclude 2nd residences, home equity loans, and mortgages over $500,000
* Limit charitable deduction with floor at 2% of AGI
* Cap income tax exclusion for employer-provided healthcare at the amount of the actuarial value of FEHBP standard option
* Modify and repeal several other tax expenditures
* Dedicate portion of savings to deficit reduction
Corporate tax reform -
* Reduce corporate tax rate to 26%
* Permanently extend the research credit

* Eliminate and modify several business tax expenditures, including:
Domestic production deduction
LIFO method of accounting
Energy tax preferences for the oil and gas industry
Depreciation rules
* International tax reform including a territorial system

Option 3: Tax Reform Trigger

* Call on Finance and Ways & Means Committees and Treasury to develop and enact comprehensive tax reform by end of 2012
* Put in place across-the-board “haircut” for itemized deductions, employer health exclusion, and general business credits that would take effect in 2013 if reform is not yet enacted
* Haircut would limit proportion of deductions and exclusions individuals could take to around 85% in 2015. Similarly, corporations would only take some proportion of their general business credits
* Set haircut to increase over time until tax reform is enacted.

I must admit – finally some progress on real tax reform. All three Options have some good items. Here are my initial “top of my head” reactions -

Option 1 is perhaps the best starting point – scrap all deductions and start from scratch to decide which tax benefits are appropriate and worth adding back. I assume that the specific elimination of PEP and Pease translates to the elimination of all phase-outs.

The creation of 3 individual tax rates and 1 corporate rate, included in Options 1 and 2, sounds good to me.

I also like the increased standard deduction and reduced mortgage interest deduction in Option 2.

Under Option 1 I would add back an increased standard deduction, increased personal exemptions for dependents only, and itemized deductions for –

• medical expenses (I would consider eliminating pre-tax treatment of FSAs but also eliminating or reducing the 7½% exclusion for medical expenses),

• real estate taxes and state and local taxes (these taxes help to provide some needed “regional equalization”),

• mortgage interest on acquisition debt (up to $500,000) for one principal personal residence only,

• charitable contributions (no limitation- other than the current 50% of AGI),

• casualty loss in Presidentially-declared areas (with perhaps the same exclusions) and

• miscellaneous employee business expenses.

Income from gambling winnings and legal settlements would be reported net of losses and legal fees (you would not have to itemize to claim the deductions).

I would not allow any tax credits. An increased Personal Exemption for dependents would replace the Child Tax Credit. The benefits provided by the Earned Income Credit, the Education Credits and the Retirement Savings Credits would be administered as separate specific entitlement programs and direct aide through the appropriate federal agencies - outside of the Tax Code.
I would have a minimum tax! Every individual whose positive gross income exceeded a filing threshold would be required to pay a minimum tax of $100. Every tax return would have a minimum tax liability of $100 ($200 on a joint return).
On the business side I would –

• eliminate all current corporate tax benefits and loopholes (except perhaps for research and development),

• allow for a “Dividends Paid” deduction,

• eliminate the deduction for depreciation of real property, wherever currently allowed (corporation, partnership, and Schedules C, E, and F), and

• provide for some kind of Section 179-like expensing.

Option 3 is basically the same as Option 1 – start from scratch and have Congress rewrite the Tax Code with a deadline and consequences for not meeting it.

I do see many problems in the process.

By just saying “add back in any desired tax expenditures, and pay for them by increasing one or all of the rates from their zero expenditure low” without limitations or restrictions we all know that the supporters of every single existing “tax expenditure”, as well as proposed new ones, will fund a lobby to throw money at Congress to keep or add their particular benefit. And individual Congresscritters will negotiate back and forth – “I’ll support your tax break if you support mine”. Before you know it we will end up with the same mucking fess we have now!

There must at least be some limitation placed on the total dollar amount of “add-backs” allowed, and serious criteria for what type of benefit can be added back.

And because 2012 is an election year I expect that nothing substantial can be done till 2013, if it is not done in 2011. So, unless it can be done in 2011, I would extend any deadline for passage of reform until 2013, to become effective in full (no “phase-in” as with 1986) January 1, 2014. Congress should extend the existing Tax Code as of December 31, 2010 (with the 2009 “extenders”), through the end of 2013.

The estate tax should be an entirely different issue that is dealt with separately from the income tax.

Once the Tax Code is rewritten the resulting Tax Act must include a provision that it cannot be changed again, in any form and by any vote, for at least five, or maybe better, ten years. There must also be some kind of prohibition or severe limitation on “temporary” tax laws that require “extending” every, or every-other, year.

To make me totally happy the resulting new Tax Code must have no AMT, no phase-outs or eliminations based on income, uniform definitions, and no “tax expenditures” for social programs that should be administered through specific government agencies other than the IRS.

So what to you think?


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