Dave Camp’s pitch to overhaul U.S. taxes: An impossible dream?

Unlike many previous Republican proposals to cut taxes, the Michigan congressman specifies how government would pay for them. This is critical, but it’s not pretty.

On Wednesday, U.S. Rep. Dave Camp (R-Mich.), chairman of the House Ways and Means Committee, unveiled an ambitious plan to overhaul America’s complicated tax code. This is both a technical and a political feat.  The number of changes is immense — the table of contents listing the provisions runs for 8 pages.  The number of political enemies created is probably equally immense.

The news that people will want to hear is the proposed cut in tax rates.  Officially, income tax rates would fall to 10% and 25%.  The alternative minimum tax would be repealed.  For corporations, the tax rate would be reduced to 25% from 35% and the tax treatment of international income would be changed almost all the way to a system that exempts foreign income.

Unlike many previous Republican tax-rate-cutting proposals, Camp’s actually specifies how he would finance these changes.  This is vital, but it is not pretty. Here’s why:

  • First, the effective rates that people would face will be higher than they might look.  There is essentially a third bracket, at 35%, for those with high income.  The proposal would phase out a variety of benefits as income rises and impose surtaxes on high-income households.  These provisions raise revenue but they also raise the effective marginal tax rate to higher — and possibly significantly higher — levels compared to the “official” tax rates.  They also complicate tax planning and filing.
  • Second, the state and local income tax deduction would be eliminated.  Mortgage interest deductions would be restricted.
  • Third, Camp adopts President Obama’s proposal to limit the value of itemized deductions. Camp would cap them at 25%, slightly less generous than Obama’s proposed cap of 28%.
  • Fourth, literally, scores of targeted provisions are slated for deletion.  Lobbyists will howl, but this is what tax simplification looks like.
  •  Fifth, there are some items that can only be described as budget gimmicks, such as an increased emphasis on Roth IRAs versus conventional saving incentives.  Because Roth IRA contributions are not deductible, a switch from traditional, deductible IRAs to Roths will raise revenue within the 10-year budget window, even though it reduces long-term revenue by even more.  Thus, what looks like a revenue increase is actually a long-term tax cut.  A number of other provisions, like phasing in the corporate tax rate cuts and reducing depreciation allowances have the same effect. They induce long-term budget shortfalls that are not accurately represented in the 10-year figures.

With all of these changes and caveats, the Joint Committee on Taxation scores the proposal as roughly revenue – and distributionally neutral over 10 years.  If this conclusion holds up over time, it is an important one, since the proposals invokes many changes moving in different directions.  For example, the personal exemption is eliminated, but the standard deduction is raised.  The earned income credit is reduced but the child credit is increased.  The net effect of these changes on low-income households is estimated to be roughly a wash.  But it will be important for policy makers and the public to think of these changes as a package.  If provisions are cherry picked, by policy makers or advocates, the proposal can be made to look much more regressive or progressive than it is.  Likewise, there are numerous provisions affecting the well-off that the proposal offers as a package.

Interestingly, despite the pro-business aura of the proposal, the proposal would cut individual income taxes and raise revenue collected from business.  The proposal does little to change Obamacare.  In fact, it would retain the high-income surtaxes that the Affordable Care Act created, though it does propose to repeal the medical device tax.

While the basic contours of the proposal are clear, there remain a lot of unanswered questions in understanding the potential impact of the proposals, in particular in terms of how the various provisions would interact.

What seems more certain is there will be immense political opposition to the changes proposed.  That is the Achilles heel of tax reform proposals that aim to broaden the base and take away people’s cherished deductions.

Still, Camp’s proposal opens the door for a potential conversation.  While it seems extremely unlikely that anything could happen soon on tax reform, it also seemed that way in the 1980s for a long time leading up to the tax reform act of 1986.