Several people have asked me what I thought about Michael Graetz's recent New York Times op-ed on tax reform (November 15, http://www.nytimes.com/2004/11/15/opinion/15graetz.html?oref=login), so I figured I should finally read it. Having done so, I must laud Graetz for remaining on message (it reiterates a couple of themes from his past writing), but otherwise its contribution strikes me as limited.
Here is Graetz's main punchline: "Rather than repealing the alternative minimum tax, as many have urged, Congress should repeal the regular income tax. Enacting a value-added tax - a tax on sales of goods and services collected at all stages of production - at a rate of 14 percent would finance an income tax exemption of up to $100,000," with a 25% rate above that.
Initial problem here: I don't know how much I trust Graetz's numbers. On page 265 of his 1997 book on income tax reform, Graetz said that a 10% VAT could finance exempting the first $75,000 of income (with a 21% rate above that). But if you read the fine print, it turned out that this would involve taxing all income, including the first $75,000, for people who earned even a penny more than that amount. So, using his 21% rate proposal, if you earned $75,000 you would pay zero income tax, and if you earned $75,001 you would pay income tax of $17,750.21 (!!). Bit of a "notch" there, as the tax techies call it, wouldn't you say? The language in his op-ed seems to suggest that he is not pulling this trick again, but it would be nice to be sure. Writers who play this kind of game in order to make the rates sound better forfeit a bit of trust the next time around.
Let's give him the benefit of the doubt on this one and return to the general contours of his op-ed proposal, which ostensibly responds to the complexity of the income tax and Congress's tendency to muck around with it. While it would be nice to take people who earn less than $100,000 off the income tax rolls, his proposal does surprisingly little to address total complexity or Congressional gamesmanship. A huge majority of people earning more than $100,000 would still, within a few years, be facing both the AMT and the regular tax, which seems to be politically intolerable and perhaps rightfully so. Plus, all the insanity of business taxation, with its economically incoherent lines between corporation and partnership, debt and equity, realized and unrealized gain, etcetera, etcetera, would remain. The billions of dollars that businesses spend on tax planning would be unaffected by the exemption. And Congress's predilection to enact sleazy special breaks for this industry and that would be unchanged - unless it got worse because there were new pressures to create VAT exemptions and special rates.
If you read to the end of the op-ed, you see that Graetz actually does have something to say about these problems. In particular, he suggests more closely linking tax and book income. This is a proposal that many have offered recently, and that I have come to agree with. In effect, it leverages managers' eagerness to increase book income against their goal of lowering taxable income. But this is hardly a new contribution, nor is the base-broadening that would have to accompany the lower rates spelled out. So the parts of the analysis that are sound are not new, while those that are new are not entirely sound.
Sorry, Michael. I will try to be nicer next time.