April 15, 1991
"Today's the Day to Figure how to Make Taxes Lower - Room for Reform"
San Jose Mercury News
By Timothy Taylor
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TAXES hinder the economy, like leeches hanging on a body.
Sorry if the analogy is a little gory. In keeping with a proud family tradition
of suffering rather than hiring help, I fill out my own income tax forms, an activity
that creates a certain amount of bitterness this time of year.
As an example, consider the case of a married Californian, filing separately.
For every $100 that person earns over $40,000, he or she will pay $33 in federal
income tax and $9.30 in state tax. That doesn't include Social Security and about
$7 (depending on county of residence) in state sales taxes, if the money is spent.
In total, less than half of the additional $100 can actually be spent for personal
To reduce the drag of taxes on incentives to work and buy, it's necessary to
cut tax rates.
Let's assume we want to keep the same level of government spending. To cut
tax rates, then, means finding a way to tax income currently excluded from taxation,
so that the net revenue, even with a lower tax rate, stays the same.
From this viewpoint, the enemy is well-defined. When special breaks are available
to some taxpayers, everyone else needs to pay higher rates to make up the difference.
Attacking tax breaks has an additional bonus of greater fairness, as well.
It makes a person's income tax burden depend more on true economic income than
on whether the income is mostly salary, or fringe benefits, or stock dividends
or interest from municipal bonds.
Of course, fairness often resides in the eye of the beholder. Rather than loading
the rhetorical dice by writing of "tax loopholes," the federal budget
provides a chart of "tax expenditures," which are benefits or programs
supported by tax breaks rather than by direct federal spending. There are 128
tax expenditure items for the individual income tax listed in the Bush administration's
recently proposed budget. Fifty of them cost the government over $1 billion per
In total, tax expenditures will cost nearly $400 billion in 1991. To put that
number in perspective, the entire individual income tax will collect only $493
billion this year. The largest tax expenditures, accounting for nearly three-fourths
of the total cost, are listed in the table.
Clearly, there should be room to scale back or eliminate at least some tax
expenditures and use the money for reducing overall tax rates. Each of us would
regret losing particular tax breaks, of course, but the overall result will be
greater fairness and lower tax rates for everyone.
This agenda for tax reform may sound familiar, because it was the approach
taken by the Tax Reform Act of 1986. By eliminating tax breaks, that bill allowed
the top federal income tax rate to be cut from 50 percent to 28 percent, thus
making taxes less intrusive for the economy and giving taxpayers less incentive
to play games on their returns.
In addition, Joseph Pechman of The Brookings Institution calculated that the
1986 Tax Reform Act also took 5 million poor people off the tax rolls, and moved
a greater share of the tax burden to the wealthy.
Consider some of the arguments for reducing or removing some of the tax expenditures
on the nearby table.
Employer contributions to pension plans and to medical care are excluded from
income taxation, thus costing the government about $100 billion. But why should
people lucky enough to work for a (usually large and stable) company that offers
such fringe benefits pay less for medical care and retirement (because they don't
pay taxes on the money used to buy them) than those who work in other jobs?
Why are only a part of Social Security benefits taxed as income, even when
they are received by elderly people who are also wealthy?
Why should the (relatively prosperous) taxpayers who itemize deductions get
a tax break for charitable contributions and for their state and local taxes,
while the (relatively poor) taxpayers who don't itemize must contribute to charities
and pay state and local taxes without any break?
Why should those who are wealthy enough to own homes be showered with tax breaks
-- deducting interest on mortgages, deducting property taxes, using their capital
gain from owning one home as an untaxed down payment on a next home -- while the
relatively poor people who rent apartments get no such benefits?
Why should someone who inherits an item on which there has been a capital gain
be able to avoid paying any tax on that capital gain?
Frankly, even if I were economic dictator for a day, I'm far from sure that
I would rigorously follow these questions to their logical conclusions. But surely,
some changes are in order.
If the government were to reduce tax expenditures by some tens of billions
of dollars, it could then take millions more of the poor and near-poor off the
tax rolls altogether, while cutting tax rates across the board. The point would
not be to raise total tax collections -- remember, the Tax Reform Act of 1986
was explicitly revenue-neutral -- but instead to collect income taxes in a more
fair and less economically disruptive way.
I can hear the complaints already, about how these tax breaks are essential.
About how this whole concept of tax reform is politically impossible. And stupid.
But remember, a reform that broadened the income tax base, cut tax rates, and
moved the tax burden toward the rich was was carried out in 1986. It could be
WHERE THE BREAKS ARE
Here is a list of the largest tax expenditures in 1991, and how much each costs
the government in lost revenue.
- Exclusion of employer contributions to pension plans $64.0 billion
- Deductibility of mortgage interest on owner-occupied homes $37.6 billion (box)Exclusion
of employer contributions for medical insurance and care $36.3 billion
- Step-up basis of capital gains at death $32.7 billion
- Deductibility of state and local taxes $19.4 billion
- Accelerated depreciation of machinery and equipment $18.2 billion
- Exclusion of Social Security benefits for retired workers $17.0 billion
- Exclusion of interest on public purpose state and local debt $15.9 billion
(box)Deductibility of charitable contributions $15.7 billion
- Deferral of capital gains on home sales $13.3 billion
- Deductibility of state and local property tax on owner- occupied homes $10.5
Source: Budget of the United States Government, Fiscal Year 1992, Table XI-1.
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