Barrons (link is subscription only, unfortunately) has an excellent cover article in next week's edition which discusses various tax reform proposals.
Barron's notes that, while divining the future is an imperfect art at best
[Tax reform] represents one of the more lofty goals ever set by a president for his second term. For the tax system is so complex that whenever you tug on a tiny thread, you risk unraveling the garment. Every proposed change to the current system could create a distinctive set of winners and losers -- and the potential losers often are politically connected. Another hurdle: The President wants any reform to enshrine his past tax cuts, even as Democrats argue that those cuts were irresponsible in light of the $427 billion federal budget deficit. In fact, they blame the cuts for that deficit. To top it off, Bush is waging this attack on the tax code while simultaneously overhauling Social Security.
Some proposed reforms put fort by former assistant Treasury Secretary Pamela Olson are interesting:
HARVARD UNIVERSITY ECONOMIST Dale Jorgenson, a tax expert who has dreamed up his own tax-reform plan -- one that taxes wages at 10% and most consumption at 30% -- suggests that the panel's final report will resemble one prepared in November 2002 by former assistant Treasury Secretary Pamela Olson for then-Treasury Secretary Paul O'Neill, who was promoting tax reform during Bush's first term until he was sacked. Olson and her team at Treasury had a firm grasp of what is both economically desirable and politically possible. And through long experience, they had detailed knowledge of the revenue implications of each of the proposals. Frenzel seconded Jorgenson's suggestion, describing Olson as one of the premier tax experts in the country. She's now a tax lawyer at Skadden, Arps, Slate, Meagher & Flom in Washington.
Olson laid out five options, the most far-reaching of which is a 20%-to-25% flat tax on consumption, to be paid mainly at the cash register. The idea is that such a tax would capture revenues from the vast underground economy, including criminals and illegal aliens who don't report income. Joint filers would have a standard deduction of about $25,000 and $5,000 for each dependent; single filers would have a standard $12,500. There would be no other deductions, not even for mortgage interest or for charitable contributions. Sellers of new homes would have to collect the tax from buyers. But existing homes would trade hands tax-free. Capital gains, earned interest and dividends also would be tax free. So there would be a big incentive to save instead of spend.
The plan would make taxes remarkably simple to compute: Tax returns would be about the size of a post- card. Wealthy people would, in effect, be hit with a one-time tax, since money in the bank would lose some of its purchasing power because of the levy. But over the long run, a consumption tax wouldn't be as progressive as the current system because the wealthy own most of the capital assets that would become tax-free.
Politically correct or not, it's an idea that has a history of appealing to voters. When magazine publisher Steve Forbes ran for president on the issue, the idea polled better than he did. In 2004, South Carolina's Jim DeMint easily beat Inez Tenenbaum for a Senate seat. Tenenbaum had made DeMint's support for a flat sales tax the campaign's central issue; her strategy clearly backfired.
Olson's second option is a flat income tax -- all wages and other forms of employee compensation, including benefits, would be taxed at single, low rate. For individuals, there would be no taxes on capital gains or investment income of any kind, including rents and royalty income (corporations would pick up the tax on dividends). There would be no deductions or special tax breaks. Rates could be as low as 15% or as high as 30% for wealthier people if Congress decides to sacrifice flatness for a measure of progressivity. In short, there's room to haggle.
A problem: There is less incentive to save. Olson points out that the approach also raises difficult issues concerning foreign investment. By disallowing interest payment deductions, returns to foreign holders of U.S. debt might decline, causing capital flight from U.S. markets and a consequent rise in interest rates.
Olson's third option is a variant of a well-known proposal by Yale Law School professor Michael Graetz -- a 15% "value added" tax for most individuals, plus a supplemental income and capital gains tax on high-income individuals. A value-added tax is a sales tax levied on materials and goods at each step in the product cycle. A refrigerator manufacturer, for instance, would pay a tax on rolled steel, copper tubing and wiring, getting a deduction later. A consumer would pay a value-added tax on the finished product, with the levy looking much like a sales tax. New home sales and new rentals would be taxed by the levy, but not existing homes.
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