Monday, November 07, 2005

Tax Reform Panel

My article on the Panel's report and recommendations should be in Tax Notes today. Summary of discussion, from the opening section, is as follows:

First, the Panel’s revenue parameters, which derive from its instructions and were not chosen by the members, are unacceptable, and thus discourage taking the plans seriously as complete packages. Although ostensibly revenue-neutral, the plans actually would lose almost $20 trillion over the infinite horizon compared to present law. More than two-thirds of the shortfall results from assuming a change in present law – that is, the law currently on the books – via extension of the 2001 and 2003 tax cuts to remain in force permanently. The rest results from testing for revenue neutrality only over the next ten years, rather than over the long term. Overall, the combined revenue loss, measured against actual present law, is almost twice the size of the infinite horizon Social Security fiscal gap that President Bush recently decried as posing a severe and immediate fiscal crisis.

Second, there is a lot of merit in the Panel’s proposals with regard to individual-level taxation. Here in particular it supplies a useful hit list, and also develops an important approach that has previously received too little attention: converting deductions into credits when accurate income measurement is not at issue.

Third, the Simplified Income Tax has a number of creative and novel features relating to the taxation of businesses. However, their workability remains in some cases unclear. Perhaps the biggest flaw is that businesses could continue avoiding tax at any level, as they often do under present law, by stripping out their taxable income via deductible interest that is paid to tax-indifferent parties. The Plan’s corporate integration rule relies on the incoherent present-law distinction between debt and equity, and it would permit businesses to pair accelerated cost recovery with debt that yields deductible interest payments.

Finally, the Growth and Investment Tax Plan, while having many virtues, is worsened by its being a quasi-consumption tax rather than a straight consumption tax. Its add-on tax at the individual level, which gives it this hybrid character, fits poorly into the rest of the structure, with unfortunate implications for tax planning at the business level, and reduces the individual-level simplification that would otherwise be possible. Without this feature, the Growth and Investment Tax Plan would clearly be much simpler for individuals than the Simplified Income Tax. From the standpoint of progressivity, raising the top rate in the Plan would make a lot more sense than imposing the add-on tax.

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