The Obama Deficit Panel’s Tax Reform Version 2.0
The chairs of President Obama’s fiscal commission have refined—in some key ways—their broad-based tax reform plan. Erskine Bowles and Alan Simpson didn’t change their basic framework from what they unveiled last month. However, the plan they released this morning—due to be voted on by panel members on Friday– is both more specific and more realistic than their initial plan.
Their first draft suggested three different reform options. And one of those—a plan that started with the radical concept of wiping out all deductions, exemptions, and exclusions—itself included multiple alternatives that would have preserved many of the $1 trillion in tax expenditures that now litter the revenue code.
By contrast, the plan released today narrows the playing field quite a lot, although it remains more of a concept than a proposal. It retains the original’s defining principle—a 1986-like reform that would preserve the income tax structure but dramatically broaden the tax base and lower the rates. While a competing reform plan from the independent Bipartisan Policy Center’s deficit commission chaired by Pete Domenici and Alice Rivlin proposed a Value-Added Tax to help reduce the deficit, Bowles and Simpson passed up the opportunity to propose a broad-based consumption tax. For instance, while they did suggest a 15-cent-a-gallon gas tax hike, they avoided any major new energy tax.
They say their plan would “maintain or increase” the level of progressivity in the tax code so that higher earners would pay a larger share of their income than low and middle-income households. The commission asked the Tax Policy Center to analyze an “illustrative” version of the plan, and we found in 2020 it would raise taxes, on average, by about $1,800. In line with the chairs’ intent, low-earners would face very modest tax increases (averaging less than $20), middle-income households would pay about one percentage point more ($600 on average), and the highest earners would pay significantly more (more than $100,000 for the top 1 percent and $700,000 for the top 0.1 percent). These estimates are relative to a current policy baseline that assumes the 2001 and 2003 tax cuts and the Alternative Minimum Tax “patch” are extended and the estate tax reverts to 2009 rules.
Unlike the 1986 plan, which was designed to neither raise nor reduce overall tax revenue, this proposal specifically aims to increase taxes—to 21 percent of Gross Domestic Product by 2022. That level itself will be a matter of huge controversy. It is about 3 percentage points of GDP higher than the post World War II average—an element that will lead many Republicans to reject it. However, many Democrats will feel it is too low given the needs of an aging population.
The “illustrative” version in the new plan would reduce rates to 12, 22, and 28 percent, and would repeal the Alternative Minimum Tax. It would tax capital gains and dividends at ordinary income rates and eliminate most deductions, credits, and exclusions. And it would slowly phase out the exclusion for employer-provided health insurance.
However, the plan would preserve the earned income and child credits (the tax code’s two main income support programs for low-income working families). It would convert the current deductions for mortgage interest and charitable gifts into 12 percent non-refundable tax credits (with limits) and permit workers to continue to make tax-advantaged contributions to retirement plans, though under tighter caps than exist today.
Finally, Bowles and Simpson would cut the corporate tax rate from 35 percent to 28 percent while eliminating most special business tax breaks. They would also shift to a territorial tax system, much like most of our trading partners, though they don’t say exactly how.
Overall, this report, along with the Rivlin-Domenici reform proposals, is a starting point for a much-needed debate over tax reform. It won’t be the last word, for sure, and may not even win the backing of Bowles and Simpson’s own committee. But I suspect we have not heard the last of it.