Even if Congress hasn’t been up to the task, don't get down. It continues to call that same play. There are at least four reform proposals, in various stages of undress, being ogled by this or that Congressional committee. One reform proposal, the Economic Growth and Family Fairness Tax Reform Plan, has been offered by Senator Rubio, erstwhile candidate for President.
Yeah! More reform. Unlike the Fair Tax proposal I reviewed in my July 17 post, which is ostensibly “fair” to everyone, the name suggests Senator Rubio’s plan is only fair for families. But, in “something for everyone” political-speak, this plan is also going to grow the economy. After all, shouldn’t we interpret a name as actually meaning something?
Until the decade of the Sixties, Congress used simple, straightforward names to identify each new tax law. Typically, the name included two parts. The first said what it was, almost always “Revenue Act” and the second the year (i.e. 1934).
The year I was born, Congress passed a tax law appropriately named Revenue Act of 1951. As it turned out, this measure directly affected my family by introducing the Head of Household filing status. My father, who raised my siblings and me as a single parent, used that filing status throughout my childhood.
Beginning with the Economic Recovery Tax Act (ERTA) of 1981, however, names given to our tax laws no longer followed any identifiable naming schema or convention. Now the names given serve to identify some economic or social malady, real or perceived, that the code intends to address. And those names have gotten worse. In a previous post, I wrote
It’s as if Congress had asked Lewis Carroll to name our tax laws. Remember the line from Alice in Wonderland, “If I had a world of my own, everything would be nonsense. Nothing would be what it is, because everything would be what it isn't. And contrary wise, what is, it wouldn't be.”
It has been said that all organizations that assign names or numbers should follow some convention in generating these identifiers.
As an example, in order to distinguish between multiple computers on a network, each computer is given a name. But some mistakenly choose terms used (some might say abused) for a different purpose. To demonstrate, suppose a database had been built on top of several computers, each of which had a different name. One machine was named "up", as it was the only one that accepted updates. Conversations would sound like this: “Is up down?” or “Is up on or off?” or “Boot the machine up.” followed by “Which machine?”
You might be equally confused when the word “reform” is used in the name of a tax code. At least five previous major tax bills include the word “reform” in their title. How’s that working out? It seems Senator Rubio learned well the naming convention called obfuscation.
Regardless, the relevant question isn’t “what’s in a name” but rather “what’s in the code?” So let’s examine this proposal. Let’s see “what’s” “what” and determine whether “up” is “down.”
His proposal includes an overview in which he explains the need for reform, excerpted below.
Perhaps no function of our government is more antiquated and dysfunctional than our federal tax system…If these problems weren’t bad enough, our complex, onerous tax code is enforced by an often unpredictable Internal Revenue Service. Simply put, our current system taxes too much, taxes unfairly, and stifles economic opportunity…
Couldn’t have said it better myself. So now the question is, under his proposal, what exactly does he intend to do about it?
His proposal is segmented into two major parts. The first—Pro-Growth Business Tax Reform—outlines measures that, in his view, will spur business investment and economic boom times. I have distilled his business proposals to four specific ideas.
- Allow full expensing of capital investment. Under the current code, investment in capital (plant, machinery and equipment) can only be deducted over time under depreciation rules, forgetting Section 179 treatment and bonus depreciation rules. He proposes to allow businesses to expense these costs, thus stimulating new investment.
- Remove interest from the tax equation. Under current law, interest expense is deductible and interest income is treated as taxable income. He asserts that current corporate tax code encourages corporations to finance themselves with debt rather than with equity, citing A Joint Report by the White House and Department of the Treasury. He suggests excluding a deduction for interest expense and removing interest income from the calculation of taxable income. One problem with this is that he specifically proposes leaving financial institutions much as they are now. I don’t know about you, but I thought most financial institutions earn much of their income from interest.
- Create one corporate tax rate. He argues, correctly, that our current corporate tax code is a confusing mix of individual and business taxes, given the “pass-through” parts of our tax code. He also asserts that we effectively “double” tax much of corporate income and levy the highest rate, reaching as high as 39.6%. His solution is to eliminate brackets and the individual rate assessed on pass-through income. He would assess one 25% “business tax rate” on C corporation income as well as on pass through income to individuals.
- Streamline the code. He argues that the current code is rife with provisions that create advantages for special interests, distort the free market and aid certain industries to the disadvantage of others. He is correct. He advocates eliminating most of these provisions, streamlining the corporate tax code.
The second section of his proposal—Creating Family Fairness in the Tax Code—addresses current provisions of the tax code that he believes treats families unfairly. I can only assume he is implying that families are treated unfairly as compared to individual taxpayers. His overview is a bit vague on this point. I have distilled his suggestions into four distinct areas.
- Consolidate tax brackets and filing statuses. He reminds us that under current law, there are seven separate tax brackets that mandate tax rates from a low of 10% to a maximum of 39.6% (excluding Additional Medicare Tax, Net Investment Income Tax and Alternative Minimum Tax), and four basic filing statuses: single, married filing jointly, married filing separately, and head of household He omits the Qualifying Widow (or Qualifying Widower) filing status. He proposes to replace the seven brackets with two—15% and 35%. He also proposes to eliminate the Head of Household status, leaving only single and joint filers. His proposal is unclear whether he eliminates MFS or simply treats those taxpayers as single. Bottom line, he says that bracket consolidation and simplified filing create a more user-friendly tax system. I would argue that those have little to do with the overall complexity of the tax code.
- Consolidate and enhance Child Tax Credits. Rubio acknowledges that several credits exist under current law. He proposes to “…maintain[s] current law for most child-related tax provisions while creating a new child tax credit…” It is not obvious to me how this plan “consolidates” existing credits. His new credit is larger than the existing credit and is refundable, limited by income tax and payroll tax (including employer payroll taxes). He argues this is necessary to eliminate the “Parent Tax Penalty” that results from payroll taxes paid by current parents plus the cost of raising children who will pay future payroll taxes. I understand the argument, I just do not necessarily agree that this creates a tax penalty.
- Consolidate the filing system. He describes the current system as “bifurcated” due to the differences in Standard and Itemized deductions coupled with personal exemptions, and noting that the AMT places another layer over all of this. His idea is to replace both the standard and itemized deductions (except for a reformed home mortgage deduction and the charitable contribution deduction), the personal exemption, and the Alternative Minimum Tax. In their place, this plan creates a personal credit of $2,000 for individuals and $4,000 for joint filers. It is not clear but I assume this language means the deductions, which lower taxable income (hence lower the income tax) would be replaced with a tax credit.
- Reform the Earned Income Tax Credit (EITC). Rubio clearly states that the design of the current tax code, particularly for those taxpayers who are eligible for the EITC, often creates very high marginal rates for the working poor, which makes working additional hours or a second job irrational. He is correct in his assessment. His proposal also suggests that any changes must be tied to changes in “means-tested” benefits.
Senator Rubio makes some good points but I find his overall proposal unsatisfactory. In many cases, he retains too much of what is in the code now. His proposal fails to address FICA taxes in any way. Whether his proposal would treat capital gains any differently than under present law is also unclear.
Despite my criticisms, his belief in the need for reform is refreshing and encouraging. I just believe his proposal falls short on what is required. In his defense, he warns that, (1) “The policies contained within this plan are just a beginning…” and (2) “The changes outlined in this paper are not intended to be a cure-all…” Having been forewarned, perhaps I should not be too critical of the fact that this proposal falls short, woefully short, of what is needed.
My dissatisfaction could be my own shortcoming. When asked whether I want a “short one” or a “tall one”, I almost always respond “make mine tall.” At just over 6’4”, I have a predisposition against things that fall short. It's a tall order but I’ll catch you back here Thursday.