A Summer Update on Tax Reform

By :: August 6th, 2013

Over the past week, Washington has been filled with news about tax reform—some reflecting necessary but painful truths and some just bad. In no particular order, here is where reform stands as Congress leaves town for its extended summer vacation:

Big rates cuts are very expensive. The congressional Joint Committee on Taxation estimated that Congress would have to eliminate trillions of dollars in individual and business tax preferences over the next decade to fully offset the cost of tax reform. JCT told senior Ways & Means Committee Democrat Sandy Levin (D-MI)  that  a plan to cut the corporate rate to 25 percent and trim individual rates to 10 percent and 25 percent and repeal the Alternative Minimum Tax would add $5 trillion to the deficit from 2014-2013. The Tax Policy Center reached a similar conclusion in 2012. In nearly all reform plans lost revenue would be made up by slashing deductions, credits and other tax preferences.  

Dave Camp Speaks. In an interview with Bloomberg TV’s Al Hunt, House Ways & Means Committee Chairman Dave Camp (R-MI) acknowledged that he’s considering changes in popular deductions for mortgage interest and charitable gifts, and may favor taxing capital gains at ordinary income rates. While Camp did not say so explicitly, trimming the charitable deduction and boosting capital gains taxes are critical to any rate-cutting reform plan. These steps would not only raise needed revenue but also are necessary to prevent rate reductions from turning into a windfall for high-income households.

Camp also said he’d try to mark-up a tax code rewrite by the end of the year and would consider tying reform to the coming battle over extending the debt limit—a fight that is likely to happen in November or December. Unlike President Obama, who backed a stand-alone corporate reform last week, Camp wants a combined individual/corporate package.

Electoral politics. 2014 Senate races increasingly intrude on tax reform, and not in a good way. Camp, who is term-limited out of his chairmanship of Ways & Means (absent a waiver by his caucus) is reportedly mulling a Senate race. Camp’s campaign would not be enhanced if he becomes identified as the guy who wants to cut the mortgage interest deduction.

At the same time, Senate GOP Leader Mitch McConnell  (R-KY) seems to be in a very tough reelection race, with a well-funded tea party candidate challenging him in the GOP primary and a credible Democrat poised to give him a tough race in November. The tea party challenge in particular will severely constrain McConnell’s ability to cut a deal on tax reform that includes any new revenues (if he ever had any attention of doing so).

For his part, Senate Majority Leader Harry Reid (D-NV) shows no inclination to bend on his insistence that tax reform raise revenue. Last week, he said any reform would have to generate “significant” new revenue.  Thus, the key issue blocking progress—how much money the new code would raise—remains unresolved.  

Obamacare and the budget.  House Republicans left town last week vowing to shut down the government in the fall unless Congress defunds the 2010 Affordable Care Act. This is not a constructive step in the direction of bipartisan tax reform.     

The Max and Dave Roadshow. Camp and Senate Finance Committee Chairman Max Baucus (D-MT) continue their modest national tour to generate support for reform. This morning, NPR reporter Tamara Keith had a nice piece on the road with the two men. It could all be summed up in the words of a New Jersey appliance store owner. Asked by Baucus if she’d support a reform that trims rates to 25 percent in exchange for cuts in tax preferences, she said sure--as long as they “get rid of some of the ones... that don’t affect me.”

 

 

 

8Comments

  1. Michael Bindner  ::  1:28 am on August 7th, 2013:

    The most important fact is that Obama had one and only one goal for tax policy – make the Bush tax cuts permanent for the bottom 98% of taxpayers while letting them expire for the rest. He not only got that, but he also got additional taxes on the wealthy to fund health care reform. Indeed, the reason Republicans really want to take down Obamacare, rather than reform it piecemeal, is that they want to repeal those new taxes on the wealthy – which in essence created a Value Added Tax paid by only the rich – although I am sure that they will pass the expenses to the businesses they own.

    It would be cleaner to simply enact a VAT, but no one is talking about that – which is why no reform will happen during this Congress. Unless someone runs on abolishing payroll and income taxes for most families and replacing them with consumption taxes (both visible and invisible), I don’t see this happening at all. I ran on this in Americans Elect – while I received a good deal of support, no one was writing checks.

  2. Tax Roundup, 8/7/2013: Tax credits! That’s the ticket! And: would low-income workers be better off without the earned income credit? « Roth & Company, P.C  ::  9:20 am on August 7th, 2013:

    […] Howard Gleckman, A Summer Update on Tax Reform (TaxVox) […]

  3. Secondary Sources: Tax Reform, Sandy Stimulus, One-Child Policy – Real Time Economics – WSJ  ::  11:51 pm on August 7th, 2013:

    […] –Tax Reform: Howard Gleckman takes stock of where tax reform stands in Washington. “Electoral politics. 2014 Senate races increasingly intrude on tax reform, and not in a good way. Camp, who is term-limited out of his chairmanship of Ways & Means (absent a waiver by his caucus) is reportedly mulling a Senate race. Camp’s campaign would not be enhanced if he becomes identified as the guy who wants to cut the mortgage interest deduction. At the same time, Senate GOP Leader Mitch McConnell (R-KY) seems to be in a very tough reelection race, with a well-funded tea party candidate challenging him in the GOP primary and a credible Democrat poised to give him a tough race in November. The tea party challenge in particular will severely constrain McConnell’s ability to cut a deal on tax reform that includes any new revenues (if he ever had any attention of doing so). For his part, Senate Majority Leader Harry Reid (D-NV) shows no inclination to bend on his insistence that tax reform raise revenue. Last week, he said any reform would have to generate “significant” new revenue. Thus, the key issue blocking progress — how much money the new code would raise — remains unresolved.” […]

  4. Jim Webb  ::  11:28 am on August 17th, 2013:

    Some thoughts on tax credits. This (perhaps too lengthy) comment details how local taxes can be changed to be more beneficial all around, but relies on an initial period of Federal tax credits for implementation. This commenter is unaware of any previous specific proposal for this tax credit strategy, but recommends articles found through commonground-usa.net for more on the topic of the two-tier property tax.

    Some simple tax structure reforms, with a proven track record known to be of benefit for communities, have been undertaken on the local level, but only in isolated instances. Analysts concluded that the popular perception of tax increases under these changes (changes made without any concomitant reciprocal tax savings such as a reduction in Federal taxes) explains the lack of their popularity. But that was before recent revelations that have brought attention to the negative outcomes associated with channeling tax money through the IRS.

    We now have an opportunity to communicate some reforms that bring a balance to the share of funds available to local jurisdictions while reducing the intrusiveness of the IRS. It would responsibly enhance local revenue by relieving taxpayers of some of their federal tax burden, so that the change would be not only acceptable, but also desirable from a community standpoint, and likely to gain support locally.

    Known as a two-tier property tax, such a local tax rate structure would involve some increases and some reductions in the composition of local property taxes. If this were coupled with a change in Federal taxes, the result could be of local and national benefit.

    Here any Local tax rate net increase would be linked to additional compensating Federal tax credits accomplished with some simple steps by Congress; acting on the Federal level would facilitate changes in local tax structures that work best if carried out nationwide.

    But what makes this a win-win proposition derives from gaining benefits, not from more funds, but from improving the use of land and resources. Market forces would be released that would work to eliminate under-utilization of good sites for development while reversing the incentives for sprawl in a way that avoids the political fracturing produced by zoning and regulatory interference on the part of city, county, state or federal governing bodies.

    Energy usage would be economized, infrastructure demands would decline, environmental impacts would be decreased, and jurisdictions would be less financially stressed both from expenditure demands and revenue sources.

    As a national program even future extra-speculative bubbles in real estate would be moderated. So the proposal would contribute to needed regulatory reform on a macroeconomic level that would lessen the upswing in the business cycle.

    The proposal would provide an income tax credit on federal individual and business tax returns to offset increased local property tax rates on land and site values. It would apply only for those jurisdictions wanting to participate. For property owners to qualify for a Federal tax credit it would require that local (usually county) jurisdictions maintain at least a 3% annual tax rate on site valuation while also conducting reassessments at market value at least every 2 years.

    This would create a two-tier property tax. It would not affect rates on improvements such as buildings or houses, but would not prevent reduction of these rates. The benefits of such a change are not evident without further discussion, but first lets illustrate a concrete case:

    A $200,000 house is currently assessed with the lot valued at $50,000, the house separately at $150,000. Current property taxes are 1% (2010 median U.S. property tax rate on homes was 1.14%) or $2,000 and thus $500 of the existing tax is for the lot usually assessed separately from the house.

    The rate is then increased 2% on the lot. But the rate on buildings or improvements would be the same or very possibly reduced from 1% to 2/3%. 2% of $50,000 is $1,000. 2/3% of $150,000 is $1,000. So this owner’s taxes are increased by $1,000 on the lot but reduced $500 on the house, hence the site tax is $1,500 and the total property tax is $2,500, the tax on the house is $1,000.

    The tax credit would be allowed on 100% of the increase in local taxes, with another 100% on the first year as an incentive. This owner would then pay $2,500 in property taxes and save $500 on her Federal taxes except this would be doubled in the first year, in this case reducing Federal taxes by $1,000 in the first year. But the overall burden for this owner would stay at $2,000, the original tax on the property.

    The credit would not transfer with sale or transfer of the property, so that a new owner would have the same higher tax rate and pay no more than $2,500 in property taxes. The expectation would be that the new owner would acquire the property at a modest discount on its original value due to the increased tax impacting on present value and so pay under $2,500.

    In this way the burden of the local tax increase on property owners would be largely compensated by the Federal income tax credit.

    Although the homeowner has only a first year net gain from the change, the fiscal position of his community would be considerably enhanced and residents would see that as a positive outcome.

    Local jurisdictions would benefit in a time when most are stressed for more revenue. For those who dislike any and all taxes, relying on local property taxes has an advantage: A local property tax is the least likely to get out of hand since it is highly visible and subject to local citizen control. We also know that citizen input and participation has more clout in trimming government excesses at the local level than in Washington.

    From the viewpoint of Congress, this would relieve pressure for Federal bailouts to local governments and municipalities. Note that the site value tax increases are not on earnings but asset values and to that extent are of a progressive nature. For those owners of limited fixed incomes localities would likely defer the increased payment until the time of next transfer of the property.

    Federal revenues would temporarily be reduced, but other likely changes at that level could certainly include eliminating deductions such as mortgage interest above a certain limit that tend to contribute to housing bubbles. Moreover a more flat income tax eliminates dead weight loss; more savings will accrue in tax preparation expenses.

    And since user fees can be more easily handled in a digital age, much of the funding on the federal level could be switched away from the income tax altogether. For instance, the expenses of keeping a military base to benefit the host country could be charged to that country or simply closed. Royalties on resource extraction on federal land could be brought in line with the private sector. Why should not the public interest be sought with a fee or rental for use of the broadcast airwaves, or by treaty for fishing rights, and to step up compensation for toxic air and water pollution?

    With respect to the IRS we need not be reminded of a system inimical to our basic sense of propriety; a system that oversteps centuries of hard won barriers between overt power and the defenseless citizen. One need only point to the requirements in the tax return. Filers are compelled to produce testimonial information in direct defiance of Fifth Amendment protection against self-incrimination. But what else is the nature of the mandatory signature on a tax return (that can be used for prosecution based on felony perjury for even careless omissions) than an imposition of the highest affront to natural liberty?

    We should keep in mind that other taxes such as on land value provide little latitude for tax avoidance and so require no intrusive self-reporting.

    Income taxes have become not merely a pecuniary burden, but also oppressive of political expression.

    The benefits to local fiscal needs are joined by benefits from avoidance of volatility in the national economy. Real estate cycles would be damped to a degree during times of euphoria. As the increase of assessment valuation keeps pace, instead of land values doubling and tripling or even quadrupling during the next boom, values would be subject to proportionate increases in taxes, so in our case above, if the underlying lot value were to double to $100,000, it would face a $1,500 increase per year tax for the lot itself. This would help to stem the run up in value before it could rise that far, and discourage boom conditions to that extent. During the housing boom, it wasn’t the cost of building a house that constituted the inordinate increase in residential home values but the appreciation of the land underneath.

    Major business cycle booms rely in part on escalating collateral backing for financial credit expansion. This reform could be useful in reducing volatility stemming from this important source. After the Great Recession it became evident to the unbiased observer that those who tried to justify boom conditions as normal failed to understand that an economy could become too accustomed to rosy outlooks. Debt and unbalanced spending were part of the problem. Monetary policy that inappropriately promoted credit had help from an infectious climate of optimism and overconfidence producing a real estate bubble.

    On the local level, to the extent that vacant property holders experience this tax increase to 3% instead of the lower rate that generally currently prevails, where lots have higher values, such as in urban areas, they would be likely to be released for more productive use. A vacant lot there may face a tax of $30,000–up from maybe $10,000 for a million dollar lot even before a property boom got underway. Vacant lots, lots with dilapidated buildings, and even parking lots would now be less desirable as simple assets held idle for appreciation or repositories of wealth.

    To the extent that lot prices ease from the higher carrying cost and as more of these go on the market, the affordability for productive entrepreneurial use improves. Yet for some homeowners in for the long run, the drop in site value would moderate the tax increase. And by not increasing rates for improvements, incentives would remain for upgrading of houses or buildings.

    By providing such an option with Federal legislation, states and localities would act to enable their own tax structure reform or miss out on the benefit.

    It’s ironic that we treat property in raw land, something hard work does not create, with more reverence than property in earnings and wages, something hard work does create. Distribution of earnings through taxes should give us more pause than allowing each of us some of what accrues to holders of titles to our natural endowment, especially when privileged by provision of law enforcement services and publicly provided infrastructure.

    Concrete examples of just such two tier rates on local property have amply demonstrated the effectiveness of this simple adjustment. Jurisdictions such as Harrisburg Pennsylvania successfully accomplished urban renewal through a two-tier approach. This required no intrusive zoning ordinances. The number of vacant structures, over 4200 in 1982, was less than 500 in 1994. With a resident population of 53,000 in 1994 there were 4,700 more city residents employed than in 1982. The crime rate dropped 22.5% from 1981 and the fire rate dropped 51% from 1982 to 1994 (The American Journal of Economics and Sociology, April, 1997).

    The overall effect of this change decreases the incentive for developers to seek land in far-flung locations often in agricultural use, or in forests or pasture in search of lower land prices. It helps correct the tendency towards sprawl and towards unbalanced public spending on new infrastructure, stimulating development away from centers of activity. In some cities 25% of the land goes underutilized with of absentee ownership holding out for property value appreciation.

    The reader is asked only to take a minute to think about urban or city property in her own vicinity that sits undeveloped, or with buildings in a blighted state. These sites, while enjoying low tax rates on land value, fetch prices kept from falling due to availability of public amenities for which costs are not shared (by the idle land) since taxes are expected to rise considerably when structures are built. At the same time one need not look very hard to find roads and highways constructed at great expense to reach and accommodate more remote locations not viable without such help.

    Under the present proposal, since a low tax rate would apply for buildings, the disincentive to new building on the lot would be removed. Instead of helplessly watching urban flight we could help correct unnecessary urban decay.

    In short the proposal would provide a motive for urban infilling as an alternative to the incentives that have heretofore produced environmentally unsound sprawl, while remaining largely tax and revenue neutral if so desired.

  5. tax reform | S&H  ::  1:55 pm on August 19th, 2013:

    […] congressional Joint Committee on Taxation(JCT) estimated that a tax plan that cuts individual rates to 10 percent and 25 percent and repeals the Alternative […]

  6. Beware of Tax Reform That Promises Deep Rate Cuts | electronics-trade Products articles blog  ::  4:55 am on December 21st, 2013:

    […] week, the congressional Joint Committee on Taxation estimated that a tax plan that cuts individual rates to 10 percent and 25 percent and repeals the Alternative […]

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