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What a clean tax code would look like

By Ezra Klein

In the New York Times today, Glenn Hubbard admits to vandalizing federal property:

When I left my job as the deputy assistant Treasury secretary for tax policy in 1993, I left a message on my office blackboard for my successor. I wrote, “Broaden the base, lower the rates” repeatedly until I filled the entire space. I then had it covered with wax so it could not be erased. (Yes, the government charged me for my bit of vandalism. But it was worth it.)

He goes on to praise the Simpson-Bowles report's tax section. That's actually the section I've found most disappointing, as it's simultaneously uncreative (it doesn't mention a carbon tax even as an option, for instance) and overly ambitious (it tries to cap tax revenues at 21 percent of GDP, which is not a decision that reduces the deficit). But I do really like one part of it: The effort to clarify how much money we spend on deductions, exemptions and assorted other loopholes. This table tells the tale (click for a larger version):

sbtaxtable.jpg

If we cleaned out the code entirely, we could raise the same amount of money by using much lower rates. The same holds true even if we preserve the refundable tax credits like the Earned Income Tax Credit and the child tax credit, as we should. Most of these loopholes and deductions are regressive and distortive -- the mortgage-interest deduction pushes people into bigger homes, for instance, and the exclusion for employer-based health care drives up the cost of health insurance.

The process they advocate -- zeroing out the code and then putting things back in one by one after we've considered them -- makes a lot of sense, and would make even more sense if we did it every 10 years or so. Unlike discretionary spending, the tax code doesn't get reviewed every time we pass a budget, and so it's a much safer home for inefficiencies and interest-group politics.

By Ezra Klein  | November 16, 2010; 1:51 PM ET
Categories:  Taxes  
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Comments

"the mortgage-interest deduction pushes people into bigger homes"

Which is why it should be converted into a principal payoff deduction, which allows you to deduct the amount you pay on your principal, rather than your interest. Thus, if you pay more on your principal in a given year, you get a higher deduction. But it will also mean less people take as much of the deduction, because, as with the principal payments, most of it gets paid off in the second half of the loan. Most people who don't pay any extra principal would have to wait until after the first 15 years have passed--while living in the same property--to really get much from the principal-payment tax deduction.

I'm tellin' ya, this encourages responsible home ownership, and isn't a sop to the banks.

Posted by: Kevin_Willis | November 16, 2010 2:08 PM | Report abuse

Alternatively you could cap the interest deduction at some percentage above the national median. If you want to buy an average house you get some help. If you want to buy a 4000 square foot McMansion in some bubble-inflated sunbelt suburb, you're on your own.

Posted by: tl_houston | November 16, 2010 2:14 PM | Report abuse

*****The process they advocate -- zeroing out the code and then putting things back in one by one after we've considered them -- makes a lot of sense*****

Even more sensible in my view would simply be getting rid of the "deductions and loopholes" altogether and replacing them with a standard, large-ish personal exemption (say, $40K.

Posted by: Jasper999 | November 16, 2010 2:15 PM | Report abuse

Can someone explain this to me:

1) Why should I give up my mortgage and property tax deductions, with a corresponding drop in my home value, so that Paris Hilton can get a 40% tax cut?

2) How does taking money from me and giving it to Paris Hilton reduce the deficit?

Posted by: HeavyJ | November 16, 2010 2:17 PM | Report abuse

@Kevin_Willis: "I'm tellin' ya, this encourages responsible home ownership, and isn't a sop to the banks."

It's still a subsidy from those who rent and pay taxes to those who buy homes and pay taxes.

Posted by: jnc4p | November 16, 2010 2:21 PM | Report abuse

HeavyJ-

Don't focus on Paris Hilton. There are plenty of elderly lecherous Republicans who would be more than willing to give her a "tax break". I think we need to focus on NBA players. They fit all the stereotypes that conservatives hate - I won't enumerate them here. So you could say "Why does Paul Pierce need a tax break???" and that would speak to them. Or maybe "How come LeBron James gets to keep more of his money while I'm struggling to pay enough to keep the NASCAR channel???". It's all about messaging.

Posted by: klautsack | November 16, 2010 2:23 PM | Report abuse

The numbers in the table are fine for discussion of what to tax but the total issue is not addressed by them. There are two criteria which should be identified and called out whenever this debate is joined. First, what is the floor income on each rate? and secondly, are all tax rates indexed for inflation?

If the top rate floor is less than $250K it should be a nogo!!!!!

Posted by: tlnixon | November 16, 2010 2:33 PM | Report abuse

I would still prefer a single tax rate that applies to anyone with any income from any source. I.e earned income is taxed at the same rate as capital gains and dividends.

If a government program is justified, then EVERYONE's taxes go up, not just other people you don't like.

I would couple this with a national sales tax (not a VAT) on all interstate transactions that aren't already taxed by a state. I.e. level the playing field between items bought at local retailers and via mail order from the Internet. You either pay your state sales tax or the national sales tax, but not both.

Posted by: jnc4p | November 16, 2010 2:41 PM | Report abuse

jnc4p,

Am I to take from your comments re: a totally flat tax that you do not believe in progressive income taxation? Therefore a family in poverty would pay the same tax rate as hedge fund managers?

Not consistent with my views.

Posted by: tlnixon | November 16, 2010 3:10 PM | Report abuse

klautsack,

Lebron and Paul Pierce are hard working laborers. They earn every cent of our paycheck.

A lot of this post sounds really good. First thing to go should be the state/local itemization of taxes.

Posted by: krazen1211 | November 16, 2010 3:46 PM | Report abuse

@tlnixon "jnc4p,

Am I to take from your comments re: a totally flat tax that you do not believe in progressive income taxation? Therefore a family in poverty would pay the same tax rate as hedge fund managers?

Not consistent with my views."

Your understanding of my post is correct.

In practice, I find the negative effects gaming of the tax code by having different rates for things like capital gains, dividends, carried interest and the various exemptions is outweighs any theoretical benefit of progressive taxation.

It also leads to the temptation of passing programs and paying for them by increasing other peoples taxes. I'd much rather have a situation where say if health care reform is passed then everyone's income taxes increase from 10% to 11% to pay for it. If a program is only justified by raising someone else's taxes but not your own, then it's probably not worth doing in the first place. Note that this logic applies to things like the Iraq and Afghanistan wars as well.

Posted by: jnc4p | November 16, 2010 4:10 PM | Report abuse

HeavyJ @ November 16, 2010 2:17 PM: Do you have any doubts that Hilton will immediately increase her discretionary spending drastically, thereby raising the economic activity, and therefore causing your employer to give you a raise that will make up for the additional taxes you'll pay?

Do you seriously doubt the benefits we have not yet seen of trickle-down economics?

PS: I am being sarcastic, of course.

Posted by: AMviennaVA | November 16, 2010 4:15 PM | Report abuse

The tax code was never just about raising revenues to cover government expenses.

Once the income tax was created, both parties used the tax code for its own brand of social engineering — Republicans mostly to cut taxes for the wealthy and reward large businesses (both heavy election contributors) and Democrats mostly to create entitlements for the lower and middle classes (again their mass of contributors via various labor organizations and unions).

It really doesn't matter who's in office. The power of the purse gives Congress the ultimate power to reward or punish in achieving party political agendas.

Congress will never give up that power. The tax code may be reworked, revised, re-engineered every decade or generation, but there will always those rewards and punishments. The military calls it command and control.

Posted by: tomcammarata | November 16, 2010 6:58 PM | Report abuse

jnc4p: "I find the negative effects gaming of the tax code by having different rates for things like capital gains, dividends, carried interest and the various exemptions is outweighs any theoretical benefit of progressive taxation."

Having different rates for different kinds of income and having various exemptions and deductions is a different question from whether there should be a progressive tax system.

Say we had a system where income was income, no matter the source. And there were no special deductions. How many people believe that a family at the poverty level should be paying income taxes? If your income level is barely sufficient to put food on the table, should a portion of your earnings be going to the federal government?

Everyone I know thinks there should be some kind of exemption for the poor. Even Steve Forbes thinks so. That means no one believes in a true flat tax, because the exemption establishes a progressive system: 0% up to the exempted amount, and another rate above it. And if you're going to have two tiers out of fairness, there's little reason not to have more: as income and ability to pay increases, that income gradually gets taxed at the "full" rate.

Posted by: dasimon | November 17, 2010 3:58 PM | Report abuse

HeavyJ: "Why should I give up my mortgage and property tax deductions, with a corresponding drop in my home value, so that Paris Hilton can get a 40% tax cut?"

First, you probably wouldn't have to give up your deductions. The law could apply only to new loans and purchases, and could be subject to a phase-out period so as not to unduly upset the real estate market.

Second, I have no problem with the savings going to debt reduction instead of lower tax rates.

Third, since much of the benefits of the deduction go to high-income earners (the higher the tax bracket, the greater the value of the deduction), eliminating the deduction in effect makes the tax system more progressive.

Posted by: dasimon | November 17, 2010 4:04 PM | Report abuse

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