Thursday, November 03, 2005

The Simplified Income Tax: Simply A Tax Increase (For Me)

by Tom Bozzo

Like Max Sawicky, I've been poring over the lengthy report of the President's Advisory Panel on Federal Tax Reform (to give it its proper name). Also like Max, it'll take me a while to absorb a lot of it, particularly the business tax provisions — the individual ones, needless to say, are much closer to my heart. I'll recommend Max's initial analysis while reserving the right to offer some additional bigger-picture thoughts of my own later.

Perhaps not surprisingly, I was most interested in what this would mean for mE! if one of the alternative tax plans were adopted. Some of the widely reported recommendations, such as the elimination of deductions for state and local income and property taxes and the conversion of the mortgage interest deduction into a 15% tax credit, didn't look very friendly.

Here's the deal: I'd classify myself as an "upper income working stiff," which is to say that essentially all of the money that puts the roof over our heads and the food in my beautiful but ravenous children's tummies comes from my salary. Suzanne works, but not for wages. For tax mavens, we're in the ballpark of the 90th percentile of AGI, file jointly, obtain credits and deductions as allowed by law for ourselves and the aforementioned two tykes, and reside in a home valued not quite twice Madison's median assessment so long as we pay our conforming 30-year fixed rate mortgage (at 5.65%). This configuration of circumstances forces us to pay a little less than 9% of our adjusted gross income in federal income tax; as I said in comments, I don't feel overtaxed.

I calculated my liability under the Simplified Income Tax, the leadoff alternative from the Panel's recommendations, from our 2004 income tax data. The reduction of the mortgage interest deduction would phase in (in a manner that wouldn't sock most people until George W. Bush was cutting brush in Crawford for his day job); I assumed full implementation of the reduced credit. The bottom line is that we'd owe 17.6% more under the Panel's alternatve than we did under the 2004 law, which is a lowish four-figure amount. This is the net effect of three factors: "broadening" the tax base by double-taxing the money paid to the state, city, county and school district, as well as by reducing the effective mortgage interest credit, narrowing the base by increasing the effective personal and dependent exemption credits, and finally reducing the effective tax rates a bit.

If I were to work this out for 2005, we'd probably fare worse, since we'll have a full year's worth of the larger mortgage on the current ranch. I'd figure our friends in Bethesda with the enormous interest-only mortgage would be well and truly screwed.

In the MaxSpeak comments, Bruce Webb observes that my demographic is probably strongly Republican-leaning, which I don't doubt. I can only expect that my righty counterparts would Not Be Amused to have a substantial fraction of the cost of fueling a full-size SUV extracted from their wallets. As such, I'd have to agree with Max and consider the reforms, with the possible exception of the proposed elimination of the Alternative Minimum Tax, to be politically DOA.
Tom, thanks for the mention. But the numeric reality is that they can't eliminate or limit the AMT without some offset. Which is why the proposal to limit the mortgage interest deduction and to eliminate deductability of state and local taxes is so raw. It just reintroduces AMT by the back door.

The AMT exists in large part to insure that people with good paychecks don't dodge taxes by buying a huge house, offsetting their tax liability by the interest costs on their mortgage, and then pocketing up to $500,000 per couple in tax free gains when they sell. All without ever contributing to the commonweal.

To the extent that the existence of the AMT discourages the erection of McMansions on postage stamp lots I am not sure at all that it needs to be swept away.
It just reintroduces AMT by the back door.

Excellent point, Bruce.
I'm giving you a De Facto trackback:

Great points, thanks!
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