Archive for Individual Income Taxes
The GOP Choice: Smaller Government or Lower Deficits
Posted by: | Comments“The goal is to reduce the size and scope of government spending, not to focus on the deficit.” Grover Norquist
You’ve got to give Grover credit. Unlike most everyone else in Washington, at least he says what he believes. In a remarkably candid interview with Ezra Klein at The Washington Post, the head of the anti-tax lobby Americans for Tax Reform beautifully described the challenge faced by Republican lawmakers today.
When the GOP was out of power, it could easily paper over a profound internal disagreement: Should Republicans be the party of small government and low taxes, or the party of fiscal prudence? At first glance, these principles sound like the same thing. But they are not. And how a deeply divided GOP chooses between them says everything about the likelihood of both deficit reduction and tax reform any time soon, to say nothing about the party’s political future.
It is much easier for Republicans to take Grover’s route and build a legislative strategy around the goal of small government and low taxes. They can focus on slashing regulation and corporate taxes (for which the business community will continue to show them the love) and on cutting a few high-profile examples of “waste, fraud and abuse” which will win them the support of many in the tea party movement.
Aiming to slash the deficit, by contrast, takes the GOP down a very different road. It carries significant political risk and, thus, requires much more courage. That’s because cutting regulation and waste reduces the deficit by depressingly little, while slashing taxes almost always makes fiscal matters worse.
There is no evidence to support the old supply-side theory that major cuts in federal taxes increase revenues. Similarly, Grover’s claim that government can discourage spending by slashing taxes (aka starve the beast) got a real world test during the presidency of George W. Bush, who cut taxes, but also spent like the proverbial drunken sailor, fathering a huge new Medicare drug benefit and fighting two costly wars. The result: Bush and Congress turned a budget surplus into a $458 billion deficit. It turns out that one doesn’t need to tax and spend when one can more easily borrow and spend.
That leaves only politically unpleasant choices. Politicians who are serious about deficit reduction, rather than modest cuts in the size of government, have no choice but to confront middle-class entitlements such as Medicare and Social Security, and support tax increases within a tax reform bill.
Based on the usually reliable rule that it is always best to judge a politician based upon what he does and not what he says, most Republicans remain squarely in the smaller government and lower taxes camp. Just look at their unanimous support for extending all the Bush-era tax cuts and their current focus on cutting only a narrow slice of domestic spending. Still, a handful of GOP pols (such as Indiana Governor Mitch Daniels) are thinking more broadly. I suspect Republicans will be fighting this internal battle throughout the upcoming presidential primary season. Watch closely to see how it turns out.
Most Businesses Won’t Benefit from Corporate Tax Reform
Posted by: | CommentsTo the Obama Administration, tax reform means corporate tax restructuring. Both the president and Treasury Secretary Tim Geithner have argued that at least the first tranche of reform would scale back tax preferences, cut corporate rates, and, in all, raise the same money that the tax code does today. In Obama’s vision, redesign of the individual tax system would wait for another day.
But there is a problem with this scheme: It appears that while all businesses would lose some tax preferences, the rate cuts would apply only to corporations. Thus, non-corporate businesses would end up paying higher taxes. In effect, firms such as partnerships, sole proprietorships, and LLCs—about 90 percent of U.S. businesses—would subsidize the rate cuts for a handful of corporations. The House Ways & Means Subcommittee on Select Revenue Measures held an interesting hearing on all this yesterday featuring, among others, Tax Policy Center director Donald Marron.
As a matter of policy, treating corporate and non-corporate businesses more equally is an excellent idea. But Obama’s approach leaves much to be desired. And as politics, this arrangement will be exceedingly dicey. The inevitable headline will be “Small Businesses Pay for Multinationals’ Tax Cut.” This headline will be wrong, but effective.
Here’s the deal: Today, corporations are doubled-taxed. They pay corporate income tax on their profits. Many of their shareholders pay tax again when those earnings are distributed as dividends or when they sell stock and receive capital gains (some, such as non-profits and foreign investors, don’t pay the extra tax). By contrast, non-corporate businesses (often called- pass-through firms) pay no income tax at all at the firm level. Instead, their profits or losses are included on the individual tax returns of their owners.
Keep in mind that while these firms report their income on individual returns, they are hardly all small businesses. Former Treasury official Bob Carroll estimates that one-quarter of firms with taxable profits of $1 million or more are organized as pass-throughs.
Donald walks through the basic math in his testimony: Corporations pay at a maximum rate of 35 cents on the dollar. Then, their shareholders pay up to 15 percent on the remaining 65 cents for a total rate of about 45 percent. Non-corporate business owners pay only a top individual rate of 35 percent. This is why nearly all businesses choose the non-corporate form.
But Obama’s concept of tax reform would change this equation. Corporations would lose the benefit of some tax breaks but in return may pay at a top rate of as low as 25 percent (Obama has yet to propose a plan so I am guessing here). Non-corporate businesses would lose those same deductions and credits, but get no benefit from the corporate rate cut. In fact, Obama would have very successful pass-throughs, whose owners pay the top individual tax rate, pay even more.
He’d raise the statutory rate to 39.6 percent and restore the phase-outs of itemized deductions and personal exemptions (worth about another 2 percentage points). Thus, he’d cut the top corporate rate to, say, 25 percent, while raising the top rate for non-corporate businesses to 42 percent. If Congress wanted to use some tax revenues to help reduce the deficit, it could raise those individual rates even more.
To make things more complicated, Obama would also raise the capital gains rate to 20 percent (with another add-on in the law to help pay for health reform). This would further disadvantage double-taxed corporations.
For real people, a decision that was once a no-brainer would suddenly become awfully complex. Do I organize as a corporation and pay a relatively low corporate rate but a rising rate on gains and dividends, or do I organize as a pass-through and pay a much higher individual rate but no second-level tax?
For politicians, the decision would be just as agonizing: Do I equalize the tax treatment of corporate and non-corporate businesses by raising taxes on the pass-throughs and lowering taxes on some corporations? Obama seems convinced that reforming corporate and individual taxes together is too heavy a lift, and focusing on corporate first will be easier. I keep thinking about that about that small business and multinationals headline and am not so sure.
What Would Happen if Congress Rewrote the Mortgage Interest Deduction?
Posted by: | CommentsThe deduction for interest on home mortgages may be the most beloved of all tax subsidies. A politician needs only to muse about repealing or restructuring the deduction to be set upon by suburban mobs (led, perhaps, by real estate agents and mortgage lenders).
But a new analysis by my Tax Policy Center colleagues Ridathi Chakravarti and Dan Baneman finds that most taxpayers would barely notice the change in their tax bill even if Congress dramatically restructured the subsidy. And with some changes, many of us would end up paying lower taxes than we do today.
In the unlikely event Congress simply repeals the mortgage deduction, the average tax bill would increase by $710. But those who earn between $30,000 and $40,000 would pay an average of about $70 more while those making more than $1 million would pay an additional $4,000.
But the deduction isn’t going to be repealed. And if it was, some of the added revenue would surely be used to buy down income tax rates. More likely, Congress will scale back the deduction or replace it with a new design such as a tax credit. With some of these alternatives, typical middle-income households would likely pay less tax, not more. And many will see no change at all.
What’s going on? Mostly, the mortgage deduction is the classic upside-down tax subsidy. It gives the biggest tax breaks to the highest earners who borrow the most money to buy the most expensive houses. Because it is a deduction, someone in the 35 percent tax bracket pays an after-tax cost of only $65 for every $100 they borrow (even less if you figure state taxes). But someone in the 10 percent bracket pays $90—if they itemize. However, because the deduction is only available to those who do itemize and a surprising number of moderate-income homeowners don’t, many taxpayers get no subsidy at all.
Let’s look at a couple of reform options. Say Congress caps the mortgage deduction at $500,000 and allows it only for primary residences (today, you can deduct mortgages up to $1 million and use the write-off for second homes). Since very few middle-income people have $1 million mortgages, you won’t be surprised to learn that almost no households making $100,000 or less would pay higher taxes. Even among those making $100,000 to $200,000, only about 12 percent would pay more. A typical household in this income class would pay about $185 more.
By contrast, about one–quarter of those making $200,000 to $500,000 and 28 percent of those making $500,000 to $1 million would pay higher taxes. If you are pulling in $500,000 to $1 million, (fewer than 1 percent of all taxpayers do) you’d typically pay about $1,900 more in taxes.
What if Congress decided to not only limit the subsidy to $500,000 loans but also turned the deduction into a 20 percent non-refundable credit? Since the credit benefits moderate-income households and most of them would be unaffected by the cap, the vast majority of taxpayers would be paying roughly the same tax bill as they pay today.
For instance, those making $50,000 to $75,000 would pay on average $80 less. Only those making more than $100,000 would pay significantly more. Households in the $100,000 to $200,000 range would pay about $650 more on average, although interestingly only half would face any tax hike at all. Those making more than $1 million would pay an extra $2,800 on average. Of course, some would pay much more.
All of these estimates assume current law where the Bush-era tax cuts expire at the end of next year. But the pattern is the same if you assume the tax cuts are extended. Indeed, typical middle-class households would do even better under the cap and credit if the 2001 and 2003 tax cuts are extended.
Higher taxes, of course, are only one result of these changes. Homeowners would likely see at least a short-term adjustment in the value of their homes as well. But it is hard to know how much and for how long. And research by TPC’s Ben Harris suggests it would depend a lot on where you lived. Of course, a cap and credit would probably result in somewhat higher prices for moderate-priced homes but lower prices for mini-mansions. The price of real mansions might not change much at all since the increase in taxes would be trivial for many uber-rich buyers.
So before you grab a pitchfork at the mere mention of a change in the mortgage deduction, take a look at TPC’s analysis. You may be surprised.