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New Year’s Resolutions for Tax Policy

January 4th, 2012 . by economistmom

cbo-policy-extended-baseline-composition-aug2011

In my column in this week’s Tax Notes–in which Grover Norquist has been named 2011 “tax person of the year,” by the way (more on that later)–I list a few new year’s resolutions for tax policy (emphasis and brief descriptions added):

[Here are] some New Year’s resolutions for those who make, study, and care about U.S. tax policy: (1) don’t view tax policy in a vacuum [recognize the interaction of tax policy with the rest of the federal budget and government's role in general]; (2) plan ahead for expiring provisions [look ahead to what's coming due in the next year, and start the policy debates and analysis now rather than in the 11th hour]; (3) accurately analyze short-term versus longer-term economic effects [how are the considered policies helpful or harmful to the economic goals of highest priority?]; (4) set revenue targets and stick to them [use the budget process and budget committees to bring tax policy into the deficit reduction effort]; (5) treat tax expenditures more like expenditures [recognize they're more like spending-side subsidies than simple tax cuts, and scrutinize them to evaluate whether their benefits are worth their costs]; (6) don’t be hypocritical about fiscal responsibility [don't fuss over the small-change items while giving a huge pass to the big-ticket ones]; (7) don’t be so afraid to agree with the other side [there's huge bipartisan common ground on goals for tax and fiscal reform if policymakers would only stop picking fights]; and (8) get specific about good tax policy [study, analyze, and better promote the specific tax policies that experts recognize as economically smart so that policymakers are forced to notice and respond].

Note that this list is more broadly applicable to fiscal policy–tax and spending–more generally, but I was writing for Tax Notes, of course.

The biggest item on this year’s expiring tax provisions list is of course (and yet again) the Bush tax cuts–or as I sometimes refer to them, the Bush/Obama tax cuts.  Who knows, if policymakers keep doing the same old thing with them, by next year they could become the “Bush/Obama/Romney [or Santorum or Gingrich or Paul]” tax cuts!

My Tax Notes column reprinted the CBO table above, just to highlight the point that these expiring tax cuts–just the ones set to expire by the end of this year–are worth $4 to $5 trillion over the next ten years, without interest costs.  (Remember the “go big” goal?)

Happy New Year to my EconomistMom readers!  More from me later this week.

12 Responses to “New Year’s Resolutions for Tax Policy”

  1. comment number 1 by: AMTbuff

    these expiring tax cuts–just the ones set to expire by the end of this year–are worth $4 to $5 trillion over the next ten years, without interest costs

    A big chunk of this is AMT indexing, preventing a reset of the AMT to unindexed levels of TWENTY years ago! Indexing to inflation is NOT a tax cut. Reversing 20 years of indexing IS a tax increase, amounting to about $8000 per year for millions of families.

    Terminology like “letting tax cuts expire” is deceptive and dishonest to the extent that it refers to reversing 20 years of indexing the AMT exemption. But if that’s the game, then I will make a better offer: Restoring government spending to unindexed 1993 levels would instantly solve the entire fiscal gap.

  2. comment number 2 by: Brooks

    AMT,

    How much of that $4 to $5 trillion reflect that (hypothetical) resetting of AMT?

    Do you have link (to CBO or other) with the figures?

  3. comment number 3 by: Arne

    This 2008 article: http://www.cbpp.org/cms/?fa=view&id=1018 seems to clarify how the AMT and the tax cuts interact.

  4. comment number 4 by: AMTbuff

    Thanks for the link, Arne. That article states that AMT relief accounts for 1/3 of the “tax cuts” in 2012. The graph shows this fraction increasing in later years, perhaps averaging 40% over the next decade. That would be $1.5 to $2 trillion of the $4 to $5 trillion figure Diane mentioned. The $4 to $5 trillion is therefore bogus, conflating ending a $3 trillion tax cut with imposing a $2 trillion tax increase, both relative to in indexed year 2000 baseline.

    Second, the 2008 article refers to holding the AMT bite at tax year 2000 levels. However there was no indexation of the AMT from 1993 to 2000. This assumption therefore preserves 7 years of AMT bracket creep rather than using the fairer (in my opinion) baseline of indexing AMT parameters back to 1993 just as the regular tax is indexed.

    Third, the AMT exemption has been “temporarily” increased year after year, but the percentage brackets remain at their unindexed 1993 levels. Those levels are now below Obama’s definition of “rich”.

    True indexation of the AMT would adjust both brackets and exemptions, just as it’s done for the regular tax. Instead Congress has frozen the brackets and increased the exemption slightly FASTER than inflation. If this bracket freeze were continued for 100 years, the result would be a tax system with a flat exemption and 2 rates: 35% for almost everyone and 28% for the very rich. (The higher rate is due to the exemption phaseout at 25 cents per dollar.) To these rates you would have to add the full state income tax rate, since that’s not deductible under AMT.

  5. comment number 5 by: Brooks

    Arne and AMT,

    Thanks for your replies.

  6. comment number 6 by: Anandakos

    Help me out here. The AMT is an approximation — admittedly somewhat crude — of a “flat tax”, something that Conservatives laud. Why not instead of the constant elaboration of the Federal Tax code just junk the major code for high-income folks and charge them the AMT?

    It’s already on the books and it’s pretty “flat”.

    All that would need to happen is to drop the upper steps of the existing income tax while stopping the indexation of the AMT. Maybe even drop the topmost step to 25% as has been advocated by some of the Republican field.

    People from the lower income ranges would pay the current stepped system while folks in the upper income ranges would pay the AMT. That would effectively sweep away enormous parts of the distorting tax expenditures because for most folks at the bottom the standard deduction is greater than the value of their itemizations. The huge fights about “targeted deductions” would melt away because they wouldn’t help the funders of the fighters.

    Campaign finance reform via the tax code. Lovely!

  7. comment number 7 by: Jim Glass

    Why not …. just junk the major code for high-income folks and charge them the AMT?

    The idea’s been floated. Remember though, the AMT doesn’t hit “high income” people, it hits people who use a lot of tax preferences relative to their income. Those are the deductions for state and local taxes, exemptions for kids, a lot of mortgage interest, medical expenses, etc.

    So the AMT doesn’t hit “the rich”, it hits the upper middle class, initially the very upper, but steadily working its way into the middle middle and downward, because it isn’t indexed to inflation.

    So, for instance, the AMT hugely disproprtionately hits people in high-tax, high cost-of-living states like NY, Mass, Calif.

    I pay it in NYC, and I ain’t rich. But I pay NYC and NYS taxes, have three kids, have a two-middle-class-earner-income family, medical bills for five people: Presto, I owe AMT.

    And believe me, state politicians in high-tax states like NY immediately go on the *warpath* against any proposal to generally further reduce the federal tax deduction for state and local taxes. It increases the real cost of state and local taxes and so restrains their spending and puts them in hot water for the high taxes they already collect.

    Whenever all the multitude of “tax the rich” Democrats here in NY get the proposal from Democrats in other states — “well, lets start by eliminating the federal deduction for state taxes paid by the rich, that’s a progressive revenue raiser” — they rise as one: “No! No! No! We will never let that happen!!”.

    Meanwhile, the AMT doesn’t hit the *really rich* at all. Capital gain income isn’t touched. Most tax-exempt bond income isn’t touched (another thing state-level politicians will never let change). So “really rich” investors aren’t touched. Really rich business owners use business tax preferences to cut their income, those aren’t affected by AMT, so they aren’t touched by it. And the really rich are already means-tested out of mortgage interest deductions, medical deductions, personal exemptions, and such, so the AMT doesn’t touch them there. So the truly rich pretty much aren’t touched by AMT at all.

    The bottom line is that the AMT lands dominantly on upper-middle class people living in the states with high state-and-local taxes and high cost-of-living, while having little impact on persons in other states, and not touching the really rich in the upper part of “the 1%” at all.

    The politics of it follows.

  8. comment number 8 by: Anandakos

    Jim Glass,

    If capital gains are not included, then you’re right, it’s not sufficiently equitable to be an affordable “flat tax”.

    So you provided a good response to my question; thank you. Clearly the AMT needs to be modernized in order to include people who receive large capital income or gotten rid of.

    But how then does the government close the $5 trillion gap? Some functions of the Federal government can probably safely be contracted out to lower cost providers. Maybe we can get by with a smaller military and international footprint. Over time we might even become loved rather than feared — we really DO have some useful ideas and practices that others can gain from.

    But all of us are going to have to pay more to sustain the government, and soon. So how do we get two to three trillion of that gap from the economy in the least harmful way?

    The simplest, most straightforward way to do so is by taxing carbon based energy, including the imputed carbon of imports. It’s a tax that can’t be avoided by arbitrage and will affect most those who spend the most. I realize there are some unique problems with a carbon tax for rural people. Perhaps something like the EIC could be devised to help them out.

  9. comment number 9 by: SteveinCH

    Nonsense. Grow government at the rate of inflation plus population (and no more) for a decade and leave the tax code as it is today and you have a nearly balanced budget. No “cuts” required.

    People really don’t understand the math here.

  10. comment number 10 by: Vivian Darkbloom

    “I pay it in NYC, and I ain’t rich. But I pay NYC and NYS taxes, have three kids, have a two-middle-class-earner-income family, medical bills for five people: Presto, I owe AMT.”

    Conceptually, I think the whole issue of AMT is much more complicated than whether one “owes” that tax. One purpose of the AMT is to provide a limit on certain items that are referred to as “tax preferences” but many of those are also referred to as “tax expenditures” (in turn, aka “spending”) such as health care costs. So, rather than viewing it as a “tax” on you, couldn’t we also view it as a limit on goverment “spending” on the Glass family?

    Personally, I’m glad there will be three additional Glasses around in the next generation of taxpayers to pay our bills and that our investment via that “spending” might not be a bad thing. But, as regards medical costs, it seems to me that the operation of AMT on those deductions is pretty similar to means testing for Medicare, etc. Isn’t it just another, albeit very complicated, way to means test some of those deductions? (As your rightly point out, the “rich” are means tested on these types of deductions (spending) by various limits such as the mortgage interest limitation and other itemized deduction limitations (Pease, if re-introduced).

    If these “tax preferences” were to be eliminated completely from the tax code, would that not solve the AMT “problem” in a very simple manner, but potentially create a larger “problem” for families such as the Glass family? To answer my own question, I think the Glass family and most other families would benefit if rates were reduced proportionately across the board to compensate for this reduced spending.

  11. comment number 11 by: Jim Glass

    Vivian, re:

    One purpose of the AMT is to provide a limit on certain items that are referred to as “tax preferences” but many of those are also referred to as “tax expenditures” (in turn, aka “spending”) such as health care costs. So, rather than viewing it as a “tax” on you, couldn’t we also view it as a limit on goverment “spending” on the Glass family?

    The AMT was created in 1969, during the Viet Nam war, when a Treasury report said that 155 people with income over $200k — about $1.2 million today — paid no income tax for the year, due to perfectly legal income exemptions, depletion allowances, deductions, investment credits, etc. The report made the TV news via Cronkite, Huntley-Brinkley and the rest, and Congress got flooded with mail and phone calls from angry voters just like it hates. But rather than fix any problems with the exemptions, alllowances, etc., that affected millions to take care of only 155 people, they just passed the first version of the AMT as another layer on top. Legislatively, it was a trivial no-thought exercise to cover a political embarrassment that was hugely disproportionate to its economic significance (155 people).

    That was the only rationale behind it, no economic analysis at all, just “get rid of these complaints”. It wasn’t inflation-indexed, but it was such a tiny thing they didn’t pay any attention to it, why bother? Then after a while it brought in enough revenue to be nice. Then really nice. Then a problem, as now high-publicity news stories started coming out about things like very middle class families with several very sick children having their medical deductions disallowed as the remedy for a handful of millionaires a generation earlier not paying any tax, legally. But by then Congress was hooked on the money.

    A couple of other thoughts popped into my mind when I read your comment.

    I was at a tax conference once where a bunch of BigWig govt officials/private sector experts were going on about how important “tax simplification” is and all their great new efforts in that direction. The person beside me looked at me and said “They have four separate cents-per-mile rates for deducting driving a car (for business, medical cost, charity, etc.) and can’t get that down to three … but they are going to simplify the entire tax code.”

    I once had a converastion with then-IRS Commissioner Margaret Richardson who spent the first half of it (rightfully) complaining about how she’d spent the morning being ripped by a Congressional committee for turning a blind eye to massive Earned Income Credit fraud (”You are educating millions of people that they can steal from the govt with impunity, this will get worse and worse …”) and the afternoon being rippied by another Congressional committee for wasting far too many audit resources fighting EIC fraud (”How can you send auditors to persecute the poor when so many millionaire tax cheats go unexamined?? It’s fiscally ludicrous and morally unjust!”). Both committees were right. But that’s how Congress designed the EIC. She was caught between it and it.

    The point of all this is: Never look for coherence, logic, or an intellectual rationale as the explanation for *anything* in the tax code when simplest, lmost-base-level politics will do.

  12. comment number 12 by: Vivian Darkbloom

    Jim,

    I left a recent comment over at tax.com where I made the observation that the AMT is a good example of Congress giving with one hand and taking away with the other. It makes no logical or economic sense, but it is perfect example of how politics destroys policy.

    OW Holmes, writing about case law wrote “The life of the law has not been logic but experience”. I think if he were commenting on statutory law it would be “The life of the law has not be logic but political expediency”.