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Because of Patriots Day, some of you in Maine and Massachusetts have an extra day to file your taxes this year. It is a good time to think about tax reform. The questions you need to answer include the following:
Territorial versus world-wide tax
Alternative Minimum Tax (AMT)
Revenue Neutral including spending changes
Corporate Income Tax
Individual Income Tax
Payroll Tax (currently FICA)
Various: Carbon Tax, Gas Tax, Death Tax, Tariffs
The Graetz plan has been touted by Reihan Salam as a comprehensive model. We generally agree and have a few suggestions and comments to go with it.
We think one easy answer is Territorial but that is controversial because the US currently one of the few countries that taxes on world-wide income. These policies lead to less investment in the US whereas a territorial system is investment neutral. We don’t think that Graetz addresses this although the PowerPoint we reviewed may not have been comprehensive. We think he should.
We think the other easy answer is to eliminate the AMT. It was originally set up to tax millionaires, from Wikipedia it was 155 households (although later it says 21):
A predecessor “minimum tax” was enacted by the Tax Reform Act of 1969 and went into effect in 1970. Treasury Secretary Joseph Barr prompted the enactment action with an announcement that 155 high-income households had not paid a dime of federal income taxes.
but it now is close to four million taxpayers paying $44 billion. This seems easy to eliminate unless you worry about revenue neutrality and the deficit. We say eliminate this complexity and get the revenue elsewhere. It is one of the many points Graetz is right on: He eliminates the AMT but is deficit neutral.
What level of spending and/or deficit do you wish? You can be a starve the beast fan but we don’t see that as working. We see the need for net revenue positive changes along with Entitlement changes to reduce the annual deficit. The Graetz plan is deficit neutral. We would love to see some major reductions in the federal government but don’t see that as likely. Look at the last four candidates for presidential nominations. There is only one that might not want to expand the federal government. Our preference is to reduce the deficit even if the reductions in the early years are modest. We believe in the growth fairy. We believe there are government policies that on average lead to more growth just as recent policies have led to less growth. These tax reforms would be one of them. More growth has great benefits for our descendants and future tax revenues.
Value-added taxes (VAT) are controversial with conservatives whereas liberals tend to like all taxes. On the one hand it can be an invisible tax that could be easily increased by government. On the other hand taxing consumption makes much more sense than taxing income and consumption is much, much less complex. We could easily choose to eliminate all the other taxes and go to VAT. We are convinced given the current tax system that VAT plus an income tax starting at $100,000 for couples as advocated by on several occasions in slightly different formats by Michael Graetz. We think much of what Graetz says makes sense. We agree that we need some income tax to go with the VAT.
Since low income folks tend to consume a high percentage of income and pay little or nothing for personal income taxes, what should we do about them getting a big tax increase? Graetz protects them by expanding refundable child credits and reducing payroll taxes for low income individuals. The impact of these changes cause the after-tax income of the lowest quintile to go up the most of any quintile while the second quintile is essentially unchanged. This makes sense to us: don’t hurt the poor and provide them more opportunities at the same time. You are not required to do this but if you don’t do you think it will be supported.
Our preference is to eliminate the corporate income tax but we agree that it would be a hard sell and difficult to replace all of it. Rather the 15% rate proposed by Graetz is such a vast improvement that we are convinced that a package like Graetz has created would be the way to go.
For individual income tax, Graetz starts at $100,000 for a couple and has three rates: 14, 27, and 31% starting at $600,000. It is a good start.
Payroll tax is the main tax for most Americans. Although the income tax collects more revenue, most of income tax revenue comes from the top 5% and very little comes from the bottom 50%. There are some reasons for payroll tax relief especially with the addition of the VAT. Graetz gives them some by giving a credit of up to $1,530 for workers making from $10,000 to $40,000. it keeps the impact on income of the bottom quintile positive.
What to do about the Carbon Tax, Gas Tax, Death Tax, and Tariffs? We are are against the Death Tax and all tariffs. Don’t forget that gas already went up by 13% (well, since taxes were moved around perhaps not) because of the VAT. Our proposal is that we end the federal gas tax, 28.4 cents, and replace it with a carbon tax so that those coal powered electric cars feel the pinch too. We are not holding out for the elimination of all tariffs but we’d really like to do away with the death tax. So we would create a carbon tax to replace the gas tax. Because there is lots more carbon than gas, we could tax it at half the rate and and use the surplus to eliminate other taxes.
Adding a carbon tax and VAT is dangerous. Frankly, if you don’t take a risk somewhere then you can’t get far on tax reform. Sensible tax reform won’t be a dead loss but it doesn’t pay for itself. Given our history, the US is in a challenging deficit position. Any real proposal needs to be at least deficit neutral. Lower rates for corporations and individuals are crucial to the future but so is the deficit. At this time we must work on both immediately.