Draft Proposed Debt Reduction Plan Released Today

The slides from a proposal by the co-chairs of the President's National Commission on Fiscal Responsibility and Reform can be found at http://www.fiscalcommission.gov/sites/fiscalcommission.gov/files/documents/CoChair_Draft.pdf

I am actually fairly impressed with the proposal. Unfortunately, some Senators and Representatives have already spoken out against it, saying they will not support it, even though they offer no effective alternative suggestions other than increasing debt. Sigh :(

Basic summary is that they propose eliminating all special interest tax deductions for individuals, and nearly all for businesses (keeping research tax credit, etc.) This allows them to simplify and lower marginal tax rates while still increasing overall tax revenue. They enumerate several health care cost savings proposals and save social security by gradually raising the full retirement age to 69 in 2075, gradually increasing the wages subject to social security taxes, and reducing social security benefits for those less in need.

Overall, the reductions are made up about 2/3 from reduced spending and about 1/3 from increased taxes, which seems a reasonable tradeoff.

Take a look, and if you think it's a step in the right direction, as I do, contact your Senators and Representatives to tell them you support such reform.

For more information on the National Commission on Fiscal Responsibility and Reform, you can find their website at http://www.fiscalcommission.gov/.

U.S. Personal Income Taxes 4

In previous postings about U.S. personal income taxes, I've repeatedly referred to special-interest tax incentives. The current tax code, Internal Revenue Title 26 of the Code of Federal Regulations (CFR), as revised April 1, 2009, consists of 14,887 pages (according the the U.S. Government Printing Office (GPO)).

Although many of the special-interest income tax laws are for the benefit of a small number of people, some are used by a substantial percentage of taxpayers. The following data is from tax year 2007 about the use of special-interest tax deductions.

Please see below. A large whitespace gap appears to be being automatically generated above the html table :(

Special-Interest Incentive	Taxpayers Who Used
some 1040 Schedule A deduction	35.83%
some 1040 tax credit	34.09%
Charitable Contributions deduction	29.15%
Home Mortgage Interest deduction	28.91%
State & Local Income Taxes deduction	26.01%
some 1040 income adjustment	25.56%
Child Tax credit	18.35%
Earned Income credit	17.43%
Self-employment adjustment	12.65%
State & Local Sales Taxes deduction	8.46%
Medical & Dental Expenses deduction	7.46%
Student Loan Interest adjustment	6.45%
Foreign Tax credit	5.41%
Education credit	5.27%
Child Care credit	4.60%
Retirement Savings Contribution credit	4.16%
Tuition and Fees adjustment	3.22%
Residential Energy credit	3.07%
Self-employed health insurance adjustment	2.72%
Educator Expenses adjustment	2.59%
Individual Retirement Account pre-tax contribution	2.34%
Gambling Losses and miscellaneous deduction	1.20%
Self-employed retirement contributions adjustment	0.84%
Early savings withdrawal penalty adjustment	0.83%
Moving Expenses adjustment	0.79%

In addition to explicit tax reductions due to income adjustments, deductions and credits, there are also lower tax rates for special-interest income, such as qualified dividend income and long-term capital gains, and an alternative minimum tax (AMT) that penalizes those who earn high incomes but not those who earn very high incomes.

While these special-interest tax incentives may have been set up for the best of intentions (e.g., to encourage charitable giving, to make it easier to afford to buy a home, and to increase investments to help grow economy), they often do so unfairly and at a higher cost for everyone else. The result is that taxpayers who do not qualify for a particular special-interest tax incentive are effectively paying additional taxes to subsidize the taxpayers who do take advantage of it.

Shouldn't everyone just pay the same income tax rate(s), and not pay more or less based on what they decide to do with their money?


U.S. GPO Bookstore for purchasing CFR: http://bookstore.gpo.gov/baskets/cfr-listing.jsp

IRS 2007 Individual Income Tax Returns: http://www.irs.gov/pub/irs-soi/09fallbulindincomeret.pdf

U.S. Personal Income Taxes 3

Unlike a flat tax that distributes the tax burden proportionally based on income, graduated income taxes subsidize lower tax rates on those with lower incomes by placing higher tax rates on those with higher incomes.

Advocates cite a variety of reasons for charging those with higher incomes a more than proportional share of the income tax burden. Interestingly, the mathematics involved also make it politically advantageous to do so, as raising tax rates for a number of higher income taxpayers permits lowering the rates for a larger number of lower income taxpayers.

Using a set of simple graduated income tax rates with no special-interest tax adjustments, I tried to generate roughly the same tax revenue distribution as the 2007 tax year for each of the 12 IRS-reported income categories. If I'm modeling the graduated tax rates based on the IRS statistical data correctly, the following income tax rates would approximate the existing tax revenue distribution based on income:

• 2% for the first $5,000 of income,


• 4% for the next $10,000 ($5,000 to $15,000),


• 10% for the next $35,000 ($15,000 to $50,000),


• 12% for the next $50,000 ($50,000 to $100,000),


• 20% for the next $100,000 ($100,000 to $200,000), and


• 24% for all income above $200,000.

Note that because highest IRS-reported income category is $200,000 and above, the tax rate for that category is higher than it should be for those whose income is near $200,000 and lower than it should be for those whose income is far above $200,000. To more closely match the current income tax distributions, there should probably be 28% and 32% brackets as well, but I don't have the information to estimate them with any accuracy.

Advantages over existing tax code:

• simple and easily understood


• simpler individual tax forms


• reduced tax calculation errors (both unintentional and fraud)


• reduced costs for Internal Revenue Service (IRS): tax form publication, tax education, tax collection, and tax enforcement

Disadvantages:

• reduced work for individual tax preparation businesses (accounting, filing, publishing, etc.)

Differences:

• does not subsidize desired societal behaviors with special-interest tax incentives, resulting in lower taxes for those people who don't take advantage of special-interest tax laws, and higher taxes for those who do


• everyone with income files separately, so multiple income households would pay lower taxes than single income households with the same overall income (e.g., no "marriage penalty")

U.S. Personal Income Taxes 2

Over the next few postings, I'd like to consider the advantages and disadvantages of a few different potential income tax strategies.

The first one I'll write about is a flat tax. As you read in my first posting about U.S. personal income taxes, a flat tax of less than 12.7% would result in at least as much income tax revenue for the U.S. government as the current tax code.

Advantages of a flat tax over existing tax laws include the following:

• simple and easily understood


• everyone pays same percentage of their income


• tax can be accurately withheld from both earned and unearned income


• income tax can be collected when income is distributed (no free loans to individuals who underpay their taxes and pay rest when file, no free loans to government by people who overpay their taxes and get refund when file)


• potentially no individual tax forms to file and thus most individual tax documentation, preparation time and expenses may be eliminated


• reduced tax calculation errors (both unintentional and fraud)


• reduced costs for Internal Revenue Service (IRS): tax form publication, tax education, tax collection, and tax enforcement

Some disadvantages of a flat tax:

• reduced work for individual tax preparation businesses (accounting, filing, publishing, etc.)

Some differences:

• does not subsidize desired societal behaviors with special-interest tax incentives


• higher taxes than currently for people with low incomes


• higher taxes than currently for people who take advantage of special-interest tax laws


• lower taxes than currently for people with middle and high incomes who don't take advantage of special-interest tax laws

I'm particularly concerned about higher taxes for people with low incomes, so the next posting will look at multiple tax rates.

U.S. Personal Income Taxes 1

What if U.S. personal income taxes were perfectly fair, and everyone paid the same percentage, with no special-interest credits, adjustments, or deductions, and the same tax rate for every type of income? How much would each of us pay?

That calculation should be easy, right? Just take the total of all personal income taxes and divide by the total of all personal income. Unfortunately, this was more difficult to discover than I thought it would be. I couldn't find IRS reporting of total income. The closest reported statistic was adjusted gross income (AGI), which already includes more than a dozen special-interest income reductions.

Naively using IRS tax statistics based on AGI and individual income tax revenue, I calculated 13.8% for both 2007 and 2006 tax years.

Using other IRS tax statistics based only on positive AGI, the rates were 12.7% for 2007 and 12.6% for 2006. A lower overall rate is likely due to eliminating the effect of reducing the AGI denominator with negative AGI tax returns that do not contribute to income tax revenue.

If we were to use total income rather than AGI, the rate would thus be lower than 12.7%. Note that this also excludes all of the people who do not file an income tax return. Including them would lower the rate even further.

So, if everyone paid the same percentage of their income in federal income taxes, the rate would be below 12.7%!

Of course, this considers neither the societal preferences that those with lower/higher incomes not only pay lower/higher taxes, but also pay lower/higher tax rates, nor the myriad of special-interest tax laws that subsidize various encouraged societal behaviors.

IRS tax statistics: http://www.irs.gov/taxstats/index.html