How Congress Violates Its Own Goals for Tax ReformPosted: November 30, 2017
This post originally appeared on TaxVox.
Bismarck is credited with the warning: “If you like laws and sausages, you should never watch either one being made.” It is never truer than with tax legislation, and Tax Cuts and Jobs Act (TCJA) is no exception.
Even the Tax Reform Act of 1986, held by many as a model of reform, resulted in its fair share of deform and complexity. The reason then was the same as it is today: Accommodating the demands of lawmakers requires special interest give-backs (reversing or modifying proposed reforms) that are, in turn, paid for with badly-designed and gimmicky revenue-raisers.
Here are just a few examples of how either the House or Senate Finance Committee versions of the TCJA would move backward from stated goals of reform: While their aim is to lower tax rates, they’d create backdoor individual income tax rate increases. They’d delay the effective dates of some provisions and make others temporary, decrying the use of such gimmicks in current law, then almost bragging that “a lot of this is a gimmick” in defining their own efforts. They’d raise taxes for many families with children in the name of reducing taxes to help them meet their living expenses, and they’d make some business taxes more complex while purporting to simplify them.
“Bracket creep” that raises average tax rates. As peoples’ incomes rise over time due both to real wage increases and inflation, they move into higher income tax brackets. Current law protects them in part by indexing the tax code for inflation using the Consumer Price Index. But the House and Senate Finance bills would use a less generous inflation index so tax rates rose more quickly as people moved into higher tax brackets faster and indexed tax credits would grow more slowly. The effect is relatively modest to start but it compounds decade over decade.
A new bubble tax rate. Copying one gimmick from the ’86 Act, the House bill would require people with moderately high incomes to pay a 6-percentage point surtax. My colleague, Bill Gale describes how this and other provisions would create a hidden combined top marginal tax rate of 49.4 percent. But the House bill adds yet another gimmick that would raise marginal tax rates even faster on more people.
The added glitch in creating a bubble top rate. Though the 1986 law, too, imposed a surtax on some taxable income, it was made transparent in a new tax rate table that showed rates of 15, 28, 33, then 28 percent. The 33 percent rate wiped out benefits of the lower income tax rates. The new bill requires a new more complicated calculation because the surtax is imposed on adjusted gross income, not taxable income. As a result, more people pay the surtax and adjustments to income that reduce taxable income, such as charitable deductions, are disallowed for purposes of the surtax.
Exchanging a higher standard deduction and an indexed child credit for removal of personal exemptions. This combination of tax policies was not based on any theory of taxation of the family. Elsewhere I have explained how it arose in response to simplistic proposals to double the standard deduction. And my colleague Elaine Maag gives examples of some of the losers. One tradeoff: Displacing a personal exemption indexed for inflation while adding a child credit that for most households would not be indexed for inflation would gradually increase taxes on families with children in a bill that is touted to be pro-family. And, oh, the standard deduction isn’t being fully doubled.
The new partnership and flow-through business rules. My colleague Steve Rosenthal details some of the problems with the new proposals for taxing “pass-through” businesses such as sole proprietorships, S-Corporations, and partnerships. These ideas would be extremely complicated for taxpayers. They’d also violate a key principle of the ’86 Act—that top income tax rates would not be greatly different for different types of income, whether earned by workers or owners, corporations or partnerships. Noncorporate tax law, in turn, has long recognized the near-impossibility of trying to distinguish returns for labor from those for capital. The traditional solution: set similar top rates for all types of income and all types of owners.
But the House and Senate bills turn this on its head by trying to lower taxes for corporations and some other business owners, but not for workers or working owners of some firms. The big winners are the lawyers and accountants already making millions of dollars finding ways to save their clients billions of dollars by changing ownership arrangements in new, creative, ways.
As Bismarck knew, the price of any “reform” is often the deal-making necessary to round up votes. If the net result is better law, these changes may be the cost of doing political business. If not, it is just worse tax law.