Wednesday, October 26, 2011

Republican Tax Proposals – Some Quick Observations

The Republicans contending to be the candidate of their party for President have put tax reform on the national agenda. The plans proffered by Herman Cain and Rick Perry have garnered the most attention.

Both these plans are bold in conception and bereft of detail. For most people, they are not really worth serious study, since they are unlikely ever to become law. Here, though, are some quick observations.

Neither plan addresses transition issues. In other words, can you get there from here? For example, many people have considered, with much encouragement, tax issues when saving for retirement. However, if the government decides not to tax dividends or capital gains, then Roth IRAs no longer make much sense and traditional IRAs would be much less attractive. I do not think Perry or Cain has been clear what the tax treatment would be for distributions from traditional IRAs and 401(k)s under their plans.

Also, the plans seem to hit moderate income people fairly hard, while giving a tax cut for the wealthy. For example, as some commenters have noted, the Cain's 9-9-9 plan consists of a 9 percent tax on wages and salaries, a 9 percent national sales tax, and the equivalent of a 9 percent value added tax. Those who devote a greater percentage of their economic income for consumption get hit harder than those who have room to save and those whose income include a significant amount of capital gains and dividends. Perry's optional 20 percent flat tax confers no benefit on those whose average tax rate is less, even though their marginal rate may be higher. Those in the highest income brackets might find it to their advantage, even after forsaking some deductions.

Neither plan is simple. There is deliberately created confusion here. A flat tax is not necessarily simple. Having different marginal rates is not what makes the current tax code complicated. Determining such things as the character, timing, source, and amount of income, as well as the eligibility for and valuation of deductions and credits are what make taxes complicated.

The Democrats would have an easy time picking apart the Cain and Perry plans, if either were the nominee.   Republicans would yell "class warfare," but I think Democrats would successfully counter that those who propose lowering taxes on the rich and raising them on moderate income workers are the ones engaging in class warfare.

Mitt Romney is apparently being more circumspect. He is making proposals that, while not likely to be enacted in their entirety and about which there can be strong disagreement, are nevertheless less ambitious and probably harder to ridicule.

Another thing that deserves mentioning is that many of those who lean Republican, including those who write the Wall Street Journal editorials, like to praise President Reagan and the Tax Reform Act of 1986. I agree that the Tax Reform Act of 1986 was a major accomplishment. But those on the right who praise this major piece of legislation forget that it eliminated the preference for long-term capital gains and taxed these gains at a maximum rate of 28 percent. I remember Charles McLure, who was the politically appointed Treasury Deputy Assistant Secretary for Tax Analysis from 1983 to 1985 and headed up much of the work that culminated in the Tax Reform Act, saying in speeches that income should be taxed the same whatever its character. Among other things, this would eliminate tax strategies aimed at recharacterizing income and losses because of tax treatment. In other words, the Treasury's position was that, borrowing from Gertrude Stein, income is income is income. Of course, the lack of preferential tax treatment for long-term capital gains was a provision which did not endure.

The case for broadening the base and lowering the rates has merit. I am all for sensible tax reform. We currently use the tax code for too many policy objectives in addition to raising revenue, though I believe that the tax code should be progressive and not have a flat rate. But why make this a priority now, when the unemployment rate is at 9.1 percent? After all, as the history since the enactment of the Tax Reform Act of 1986 demonstrates, the Congress will always be making changes to the Code and undoing even good ideas.

As for the Cain and Perry plans, they are not thought through. Again, borrowing from Gertrude Stein, "there is no there there." 

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