TaxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. Foundation President Scott Hodge recently published an article in the Heartland Institute’s Budget & Tax News on the opportunity for federal tax reform during the next administration—regardless of who wins. The article outlines five basic steps to politically realistic tax reform:
For the first time since 1986, the stars may be aligning for a grand bipartisan compromise on fundamental federal tax reform.
Regardless of who wins in November, the next president and Congress will have to deal with the collision of two cataclysmic tax events: The 2011 expiration of the Bush tax cuts and the growing irritation of the Alternative Minimum Tax (AMT)The Alternative Minimum Tax (AMT) is a separate tax system that requires some taxpayers to calculate their tax liability twice—first, under ordinary income tax rules, then under the AMT—and pay whichever amount is highest. The AMT has fewer preferences and different exemptions and rates than the ordinary system. .
The seeds for compromise lie in the fact that both sides have something to gain by addressing these problems at once. Naturally, Republicans want to avert the largest tax hike in history by maintaining the lower tax rates on income, capital gains, dividends, and married families with children. Meanwhile, Democrats will be brought to the table by the fact that the AMT is largely a Blue State problem, mostly affecting those living in high-tax and high-income states such as California, Massachusetts, New Jersey, and New York.
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Step 1: Eliminate tax exemptionA tax exemption excludes certain income, revenue, or even taxpayers from tax altogether. For example, nonprofits that fulfill certain requirements are granted tax-exempt status by the IRS, preventing them from having to pay income tax. s and deductions.
More than 80 percent of the benefits of these tax deductionA tax deduction is a provision that reduces taxable income. A standard deduction is a single deduction at a fixed amount. Itemized deductions are popular among higher-income taxpayers who often have significant deductible expenses, such as state/local taxes paid, mortgage interest, and charitable contributions. s flow to households earning more than $80,000, and more than half of the benefits flow to those making more than $118,000.
Eliminating these deductions would solve several problems. It would free up dollars for marginal rate cuts to keep effective rates down, and it would add greater simplicity and equity to the tax code.
Affluent taxpayers may be the initial beneficiaries of these tax exemptions and deductions. But in the end, the real economic subsidies flow to well-heeled interest groups such as the housing industry, state and local governments, and public employee unions.
In particular, the state and local tax deduction allows local politicians and school districts to shift as much as one-third of the cost of any tax hike along to Uncle Sam–and thus other taxpayers.