THE END OF THE MIDDLE | Taxes

All agree that tax code is broken, but how to fix it

Updated: 2012-10-28T01:14:15Z

By DAVE HELLING

The Kansas City Star

The federal government collected roughly $2.3 trillion last year, money it used to pay for everything from tanks to food stamps to flood control.

Almost half came from individual income taxes. The federal income tax is progressive — the wealthy pay more. In fact, about half of all Americans pay no federal income tax at all.

Another third of the government’s revenue came from Social Security and Medicare taxes, payroll taxes paid by workers and employers. Both are regressive — the tax rates are flat, Social Security taxes are capped and investment income isn’t included.

Virtually all working Americans pay Social Security and Medicare taxes.

The rest of the government’s revenue, about 17 percent, came from taxes on corporations, excise taxes like those on gasoline and airline tickets, and various fees.

Almost all of the major tax reform proposals now under discussion involve changes to individual income taxes. There is talk of raising gasoline taxes and Medicare taxes for the wealthy, and the payroll tax, which was cut for workers two years ago to stimulate the economy, is likely to go back up, but lawmakers are largely focused on the income tax code and tax rates.

Republicans

Mitt Romney’s plan calls for a 20 percent across-the-board reduction in tax rates. The current top bracket of 35 percent, for example, would drop to 28 percent. The 10 percent bracket would become 8 percent.

A flat-rate tax cut would be regressive, though, so Romney has also promised to reduce or eliminate tax breaks for wealthier taxpayers so their overall burden would remain the same. “I will not under any circumstances reduce the share that’s being paid by the highest-income taxpayers,” the GOP nominee said in the second presidential debate.

So he’s recently suggested a cap on deductions and exemptions to accomplish that goal, but he hasn’t specifically said what the cap would be — he suggested $25,000 in the second debate but mentioned $17,000 earlier in the campaign.

Popular deductions and exemptions include home mortgage interest, contributions to retirement programs and charities and the absence of taxes on employer-based health insurance.

Romney has promised to extend the Bush-era tax cuts for all taxpayers, eliminate the estate tax and the Alternative Minimum Tax, and end taxes on interest and investment gains for middle-income taxpayers.

He proposes cutting the corporate tax rate from 35 percent to 25 percent. And he would repeal tax increases embedded in the Affordable Care Act, including higher Medicare taxes for the wealthy, as well as taxes on high-end insurance programs, some medical devices — and tanning parlors.

Even conservatives and other Republicans, as well as most Democrats, say achieving all of Romney’s tax goals without increasing the federal deficit is virtually impossible without substantial cuts in federal spending.

The Tax Policy Center, a left-of-center think tank, issued a recent study concluding deductions like those for home mortgage interest and charitable giving would have to be reduced for the middle class to “pay for” Romney’s tax cuts. It concluded that those making less than $200,000 a year would pay $86 billion in extra taxes each year, while those above that level would pay $86 billion less.

“It is not mathematically possible to design a revenue-neutral plan that ... does not result in a net tax cut for high-income taxpayers and a net tax increase for lower- and/or middle-income taxpayers,” the study concluded.

Not everyone agrees. The Tax Foundation, a more conservative think tank, recently said capping deductions at $17,000 would make the Romney plan largely revenue-neutral and still cut tax rates for almost everyone.

But the Tax Foundation and Republicans assume the tax cuts would bring what’s called “dynamic scoring” — greater economic growth that would yield billions in additional tax dollars. “The benefits from these things spill over,” the Foundation wrote.

Democrats call the theory “trickle-down” economics. They’ve claimed the Romney plan would add almost $5 trillion to the national debt over 10 years.

Democrats

President Barack Obama’s tax proposals are much less clear. He would eliminate the Bush-era tax cuts for those making more than $250,000 annually, making the top federal bracket 39.6 percent. He also supports replacing the Alternative Minimum Tax with the so-called “Buffett rule” requiring those with incomes above $1 million to pay an effective rate as high as middle-class taxpayers.

He’s also promoted higher taxes on capital gains for higher-income payers, as well as higher levies on some dividend income. He would keep the Bush-era tax cuts for those making less than $250,000 a year, and he wants to reduce the corporate tax rate to 28 percent for most companies, although he’s also called for eliminating loopholes like those for oil and gas companies.

Obama would keep the tax increases in the Affordable Care Act.

The 2013 budget claims spending cuts and tax hikes would cut $4 trillion from projected budget deficits over the next 10 years, but earlier this year the Congressional Budget Office said the budget would still add $6.4 trillion to the federal deficit between 2013 and 2022. The budget would never balance over the next 10 years, the CBO said.

Paths to compromise

No issue is more important to the nation’s fiscal future than taxes. Republicans have bitterly resisted tax plans that raise significant revenue, while Democrats have refused to consider reductions in popular entitlement programs without some federal tax revenue in return.

All sides agree the tax code is too complicated, so compromise could include simpler tax laws with fewer tax brackets. And there is broad support for popular deductions like home mortgage interest, state and local tax payments, and charity contributions. So compromise isn’t likely to include changes to those rules.

Full progress is virtually impossible, though, until both sides compromise on tax burdens for the wealthy. One idea: adopt Romney’s plan of capping deductions and exemptions, but leave rates intact. That could mean more revenue from wealthy taxpayers without increasing their rates.

In return, Democrats would have to agree to reform entitlements such as Medicare.

In the second quarter of 2012, federal taxes were 17 percent of GDP while spending was 24 percent of GDP. The last time the federal budget was balanced, revenues were 19.5 percent of GDP while spending was 18.2 percent.

Spending cuts and revenue increases will almost certainly be required for any compromise that balances the federal ledger.

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