Rarely is there an issue as contentious as taxation. Thick walls of partisan gridlock form around taxes like very few other issues. Reform is supposed to be a kind word and describe a way to make taxes simpler for people to understand, but the tax code actually sees changes on a regular annual basis or so. The problem is these changes haven't made things simpler for taxpayers.
True reform -- like a comprehensive restructuring of the tax code from the bottom up -- is the ideal goal, but realistically there are strong forces to maintain the status quo.
U.S. Rep. Dave Camp (R-Mich.), chairman of the powerful House Ways and Means Committee, made tax reform his final legacy before retiring at the end of this session. To appease both sides, there are items in his plan that both Democrats and Republicans dislike.
- Step 1: Lower rates so individuals save more come April 15.
- Step 2: Eliminate or cap deductions and credits so individuals can’t lower their taxes further thereby saving money for the government.
- Step 3: Phase out such deductions and credits for high-income filers so as to create a more progressive system.
The chairman from Michigan wants to lower the current tax bracket limits to only three: 35 percent, 25 percent, and 10 percent.
Not all credits and deductions will be eliminated as they do serve a purpose -- the child tax credit and mortgage interest deduction, for example. These two are commonly referred to because they greatly impact families and major economic decisions.The child tax credit is still there to help parents raise their growing families. The mortgage interest deduction is still in the Camp Plan -- albeit at a lower cap -- to keep home buying a part of the American Dream.
Caps are pivotal because they limit how much one cam claim on a deduction since deductions cost the government money. Currently, a person can deduct state and local taxes on his or her IRS return thereby limiting their liability, or how much they owe the IRS.
Capital gains taxes are more commonly utilized for the wealthiest earners like Warren Buffett and Mitt Romney. That is not to say middle-class earners can't invest, but they likely don’t make the vast majority of their income from investments. Capital gains taxes complicate returns by piling on additional forms, not to mention the carried interest/income for investment managers.
These wealthy investors are powerful figures in politics and changing the way they earn their income is like walking on a tight rope.
The trick to altering capital gains taxes is eliminating the 15 percent and 20 percent special tax brackets and capping what will be taxed at 60 percent of the income. This creates practically no change for middle-income earners and little change for the wealthy.
So far, Camp’s proposal makes tax reform appear like a typical Republican effort: lower rates and deductions to create as close to a net-zero gain while simplifying the system. To gain a few votes from Democrats, the chairman left in the 3.8 percent premium tax for Medicare on investments for filers in the top bracket.
There is also a “Too Big to Fail” tax on large financial institutions with over $500 billion in assets. A small 0.035 percent quarterly tax on these businesses can generate over $80 billion over the next decade. This rubbed many wealthy political donors the wrong way -- so much so that their lobbyists from the American Bankers Association, other interest groups, and friends on Capitol Hill opposed this bank fee tax.Aside from this opposition as well as the greater obstacle of this debate falling in an election year, there have been previous attempts at revamping the tax code. Many enjoy lower tax rates, but there is a limit to how low it can go without putting the government coffers in danger.
The tax plan Mitt Romney proposed during his final presidential bid called for cutting taxes by 20 percent, taking out the estate tax, and eliminating capital gains taxes altogether for people making less than $200,000.
Romney not only failed to provide specifics, but enacting these changes would have severely reduced government revenue. There are other examples of reform proposals, but that could be the topic of another article.
With Camp retiring and the Republicans more than likely to retain control of the House, Rep. Paul Ryan, another budget wonk with his own proposals as Budget chairman, may replace Camp. This was mentioned months before the retirement announcement, but that was because chairmanships have term limits. Camp's retirement just may have pushed up Ryan’s plans.
Tax reform requires careful deliberation between Democrats and Republicans. The Camp Plan contains elements that many in both parties will consider. Speaker Boehner even said it is a good place to start. However, that doesn’t mean it will pass this year.
Even without an election year, politicians need to explain the benefits of lower tax rates with the negatives like fewer deductions. Voters may not fully comprehend the issue and there will always be a candidate saying the other person is wrong.
For however big tax reform is, it is a pivotal tool to combat the national debt and that is an issue both sides should fight for.
Photo Credit: Andrew Harrer / Bloomberg