Monday, November 07, 2005

The Tax "Reform" Panel's Report: Some Thoughts

by Tom Bozzo

While tax "reform" may be deader than a dead dodo, in the spirit of teaching Democratic strategists a lesson from the other side's not-necessarily-evil behavior, I will not refrain from kicking it when it's down. This is in no way a comprehensive list, as I only have so much leisure time to devote to poring over the report.

(Welcome Economist's View readers. A roundup of previous posts on tax reform issues is here; a follow-up post on regional variation in the proposed mortgage interest credit is here.)

1. Having Democrats around does matter

Had the panel recommended a consumption tax or a progressive wage tax a la the "X Tax" — thereby offering political cover to the right's goal of exempting investment income from taxation — a host of tax policy analysts from the AEI, Cato, Heritage, etc. would have been walking around resembling "Nail's Tales." Tom DeLay, I'm sure, would be describing the reforms as gilding the deck chairs on the Queen Mary 2 rather than re-arranging same on the Titanic. Some credit for this not happening must go to John Breaux, otherwise hardly a progressive's progressive, and other representatives of the center on the panel, who at least were not going to let zero rates for personal investment income fly.

2. Lies, damn lies, statistics, and marketing

Max Sawicky is right that the report is not only a policy analysis document. It's full of non-functional illustrations like this one, meant to dramatize how much better it will be to fill out the proposed 1040-SIMPLE than the existing 1040 (non-EZ, I presume):
Preying on fear of math may be effective, though doing so on page 107 of a several hundred page report overestimates the mean level of wonkery in the target audience.

The reality is, the existing income tax is not complicated at all for wage and salaries income, which accounts for the vast majority of income for the vast majority of taxpayers. Features like graduated tax rates don't count since tax tables turn the calculation (not advanced math to begin with) into a simple lookup, and anyway there are these things called computers and e-filing initiatives have driven the price of tax software effectively to zero.

The Simplified Income Tax alternative, meanwhile, introduces new complexity — e.g., regionally variable limits on the mortgage interest credit — and retains other forms, such as preferential treatments of some investment income. This provision may look simple:
(p. 108) Exclude 100% of dividends of U.S. companies paid out of domestic earnings.
Quick, define U.S. companies and domestic earnings! Does the former include tax-avoiding expatriates? Can you figure the latter while decreasing (other things equal) the level of employment in the transfer pricing business?

3. Dept. of "Are you kidding me?"

The report does, early on, express a touching bit of concern for the possibility that tax rates distort labor supply decisions. When I was a student, some conservative economics professors actually were concerned about such things, before the obsession with capital market distortions took over. This, however, has to be the worst example ever:
(p.6) Let’s say you are just offered a great job at $120,000 a year. You are married with one child and your current salary is $80,000. You take the job, right? Not necessarily. The increase in salary might cause you to lose some of the child credit – and subject you to other provisions that increase your total tax bill even more, such as the alternative minimum tax. In all, the pre-tax jump in your new salary may be $40,000, but it could end up costing you an extra $9,203 in tax – meaning that your salary would rise by 50 percent while your tax liability would increase by 140 percent. Not surprisingly, some workers figure this out quickly and avoid taking on work... simply because of how the tax code penalizes that extra effort.
Forget for a moment that $120,000 is in a sufficiently high percentile of the wages-and-salaries distribution that relatively few people will have the problem of making the decision. Those percentages are highly misleading. Yes, tax increases more than income since the marginal rate on the extra $40,000 is higher than the average rate on the previous $80,000.

But let's rephrase the problem. Define "great job" how you will. Would you forego the after-tax $30,797? (If yes, really? Why?)

More later...
Nice post, Tom. You've somehow made the tax code interesting... which confuses and frightens me.
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