Yesterday, Congressman Dave Camp (R-MI), the House Ways Committee Chairman, released his draft proposal for comprehensive tax reform. The mere proposition of positive tax reform is a welcome development. Even though we clearly lack the votes to enact any tax reform until at least 2017, it is still important to stand on bold colors and offer an alternative vision to the current socialist path from this administration.
On the other hand, if we are going to propose Republican ideas for tax reform just for messaging purposes, we should put forth the boldest tax plan possible – one that embraces completely the concepts of fair and flat and not one that is tendentious or punitive towards any group of people or individual. It’s not that a compromised version of tax reform isn’t better than the status quo, but because this is an exercise in messaging, we should propose a bill that fully adopts conservative principles and eschews every premise of class warfare. The purpose is to talk about ideas and principles, not try and win points for being measured in our approach.
The conservative principle of any tax reform – short of wholesale repeal of the 16th Amendment and implementation of the Fair Tax – should have the following goals in mind: it should tax everyone at the same low rate (at least on all income above a certain minimum), that rate should be just enough to net the minimal amount of revenue to sustain a constitutional government, and done so in a way that engenders the least amount of disincentives to produce and invest in the economy.
Obviously, we have to deal with a short-term reality that we don’t have a constitutional form of government and the current obligations require a certain level of revenue. But the closer a tax plan gets to following those principles, the more utility it will have in uniting us behind a starting point for future negotiations.
With these principles in mind, it is fair to say the Camp proposal is, at best, a mixed bag. Here are some of the key proposals for the tax code pertaining to individuals:
Good provisions
- Individual Marginal Rates: Camp’s bill would collapse the current system of seven tax brackets into just two levels of 25 percent and 10 percent. Hence, the top marginal rate would be reduced from 39.6 percent to 25 percent. It’s not the preferred flat tax, but at least it’s headed in the right direction. The tax cut is further enhanced by expanding the standard deductions to $11,000 for individuals and $22,000 for married couples – up from $6,100 and $12,200 respectively. [However, a portion of that tax cut would be offset by repealing the $3,900 personal exemption.]
- It abolishes the AMT (Alternative Minimum Tax).
- The deduction for state and local taxes would be eliminated. In theory, this is a good thing because we don’t need the federal government to soften the blow of high taxation in blue states, thereby shielding bad actors in local government from the wrath of their constituents. However, as is the case with the mortgage interest deduction [see below], eliminating deductions is only a net positive if marginal rates are dropped low enough to engender a decrease in the effective tax rate. Under this plan, it’s conceivable that some people will see their effective tax rates increase.
- The plan gets rid of all the green energy social engineering in the tax code.
Bad provisions
- Surtax: If Camp would have stopped at lowering the top marginal rate to 25%, it wouldn’t be perfect but it would represent serious progress. However, his plan would impose a 10 percent surtax on certain types of earned income over $450,000 a year. This is a big shout-out to Obama-style class warfare and fundamentally accepts their false premise that the tax code is not progressive enough. What’s worse this surtax would apply to healthcare benefits (and the deduction for self-employed), contributions to retirement accounts, and untaxed Social Security benefits. If the point is messaging with this plan, including this provision does nothing but solidify the class warfare argument as an accepted premise.
- Mortgage Interest Deduction: Under this proposal, the $1 million limitation on the mortgage interest deduction would gradually be lowered to $500,000. The mortgage interest deduction is the biggest market-distorting provision in the tax code, inducing an inflationary effect in the housing market. In a true limited government/free market system, we would have a perfectly flat tax at a very low rate, and then completely abolish this deduction. However, the Camp plan only reduces the rate to 25% with those earning over $400,000 paying a de facto rate of 35%. So cutting down on the deduction could represent a massive tax increase, especially when coupled with the elimination of other deductions. Although conservatives would like to see this deduction repealed, under the Camp system it would be better to leave it alone. There are also a number of phase-outs of itemized deductions and the standard deduction for higher income earners.
- Although Camp would make cuts to the Earned Income Credit, he would expand the Child Tax Credit from $1,000 per child to $1,500, and increase it with inflation. If we would abolish the refundable nature of the credit (the ability to make money after zeroing out the tax liability), this would represent pro-growth, family-oriented reform. However, this change would increase the cap on the refundable portion of the tax credit from 15 percent of earned income [under current law] to 25 percent.
- Capital Gains: Under current law, investment income is taxed at a flat rate of 20 percent. Under this proposal, 40 percent of one’s annual investment income would be completely exempt but the other 60 percent would be taxed at the rate of the filer’s income. This is a surreptitious way of raising capital gains taxes on those in the new 35 percent tax bracket.
Overall, the basic components of the plan are a step in the right direction. But when you cut through the changes in deductions and phase-outs, it is clear that many people at the top – those who already pay 38 percent of the income taxes, will be hit with higher effective tax rates. Additionally, it’s likely that the plan would make the tax code even more progressive.
A flatter, lower tax rate without deductions is the best path to real tax reform, but it all depends on how low the marginal rates are dropped and how severely the deductions are cut. The balance in this bill is a bit concerning. And the myriad of proposals used to sneak in tax hikes actually run counter to the original purpose of the Camp bill – to make the tax code simpler.
Camp should be applauded for moving beyond platitudes and actually proposing a specific reform plan. But if this is meant to be used as a messaging tool, much of the proposal is not grounded in conservative principles of tax reform.