Joel Slemrod and James Hines
Ross School Tax Experts Simplify the President's Tax Reform Panel Report
Professors Joel Slemrod and Jim Hines of the Office of Tax Policy Research address key questions about the current U.S. tax system and possible reforms.
ANN ARBOR, Mich.—President Bush charged the Advisory Panel on Federal Tax Reform with finding ways to simplify the nation's tax laws. Now, two University of Michigan tax experts offer a simple and clear guide to understanding the recommendations of the panel, whose report will be issued Nov. 1.
Joel Slemrod and James Hines of the U-M's Office of Tax Policy Research (OTPR) at the Stephen M. Ross School of Business provide answers to 12 key questions about the current income tax system and possible reforms, which can be found on the OTPR Web site: www.bus.umich.edu/OTPR/.
"Since the findings have not yet been released, we offer commentary on aspects that one can reasonably expect the report to include and a guide to how to read between the lines to see how the critical tradeoffs of tax policy were resolved," Slemrod said.
According to Slemrod and Hines, the panel will probably provide a series of options for tax reform, not a single plan. These options, they say, most likely will include both a reformed income tax and some variant of a consumption tax. The panel has already signaled that it is likely to propose abolishing the individual alternative minimum tax, which left unchanged will require more than 20 million taxpayers to calculate tax liability two different ways and pay the greater of the two amounts.
"The report is sure to stimulate extensive debate about ways in which the U.S. tax system might be improved," Hines said. "That the system could be improved just about no one doubts. But whether any particular reform, as ultimately shaped by Congress, and modified over subsequent years with rounds of revision and reform, actually represents a step forward is another matter."
Some of the issues addressed by Slemrod and Hines include:
—Is the current tax system broken? Will a reformed system share tax burdens more fairly and simplify the tax system? Simplification for the average taxpayer may require settling for rough justice and abandoning the use of the tax system as a vehicle to reward favored activities and constituencies. Can Congress resist the urge to maintain a system filled with targeted rewards?
—What makes the cut? Is a national retail sales tax on the list? Preliminary indications are that it will not be. Even the ordering of the alternatives might matter and it is worth seeing if the obligatory income tax option is damned with faint praise.
—What's an X-tax? The panel may present consumption tax alternatives that look nothing like a retail sales tax, with unfamiliar names such as a consumed income tax or, most mysteriously, the X-tax. These look less like a retail sales tax and more like a wage tax, under which interest, dividends, and capital gains are no longer part of taxable income.
—Soak the rich or the middle class? Look to see if the proposals shift who bears the tax burden, especially at the top of the income distribution, where a flat-rate system inevitably lightens the tax burden on the highest-income families, and at the bottom of the income distribution, where the current earned income tax credit has become a very important federal income support program.
—Whose ox is gored? Even if there is no big change in the average tax burden across broad income group, major tax reform brings winners and losers. Losers may include
those who benefit from current loopholes, credits and preferences; the elderly, because shifting to a consumption-based tax can punish those who have already paid income tax and now must pay again as they spend down their savings; "blue state" residents, because sweeping away itemized deductions such as those for state and local income and property taxes tends to hurt higher-income residents of high-tax states like California and New York; and members of "traditional" families, as some tax reform plans eliminate current tax benefits for large families, such as dependent exemptions and child care credits.
—No more April 15 jokes? Under some reform proposals, individuals would never again have to file tax returns or at least no one with an income less than $100,000 would have to file. Even if most people will still have to file a return by April 15, the filing process could be greatly simplified. But do not be fooled by claims that the IRS could be abolished. Any U.S. tax system needs to collect close to a trillion dollars annually, which means that some individuals and businesses will try to avoid paying their obligations, so there has to be a government agency to enforce the laws.
—Sacred cows. If you thought Social Security was the third rail of American politics—touch it and die—think about the deductions for mortgage interest and charitable contributions. Early indications that the panel will propose limiting mortgage interest deductions and restructuring tax benefits for charitable contributions have been greeted with widespread alarm. For the most part, a tax system is simpler the less it singles out particular activities for special tax treatment. Tax preferences for either charity or mortgages do not fit easily with most consumption tax plans, and can cause serious structural problems if they are retained in their current form.
—The grass is always greener. Enumerating the problems with the current tax system is easy enough, for there are many. But alternative systems look simpler on paper than they do in operation, when it is necessary to deal with real-world details, and when private parties pick them over for loopholes and inconsistencies and lobbyists and legislators resume their dance to reward favored constituencies.
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