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Flatter Taxes and Fatter Bases: An Evaluation of Current Proposals

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Special Academic Paper

Executive Summary
The Treasury Department’s November 1984 Report, the Bradley-Gephardt bill and the Kemp – Kasten bill — are evaluated, with most attention to the more comprehensive Treasury report. The plans are evaluated principally for simplification objectives and economic impact. Simplification is considered in terms of both ease of compliance and for 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. /investment planning. A scorecard on eighteen major provisions of the Treasury cutting across the economy reveals the following:

Twelve of the eighteen would be considered improvements for compliance purposes but only seven improvements for tax/investment planning. Eight of the proposals are seen as further complications for planning purposes and the net effect of three is unknown. Simplification both for compliance and planning is more evident for individuals under the Treasury program than for corporations. The most notable exception to the prospective general simplification for individuals would be the plan to repeal numerous statutory fringe benefits which would not only complicate tax compliance but have a major impact on employer – employee relations. On the corporate side, of eight major proposed provisions mainly affecting corporations, compliance improvement is noted in half of them but improvement for planning in only two.

In general, the Treasury plan would make some significant progress toward simplification particularly in compliance. But the simplification objective is compromised by other tax reform considerations especially the proposed spread of indexing and new measurements of income in the business sector. While no separate rating of the Bradley-Gephardt or Kemp-Kasten provision has been made, it appears that they would offer somewhat less overall simplification for compliance purposes than the Treasury program but also involve less planning complications than the Treasury program. Both congressional programs are considerably more limited in the reach of their provisions.

There is much controversy over the economic impact of these tax reform plans. All of them would curtail severely the capital recovery provisions of the present system. Any of them, if enacted, would mark a drastic reversal of the U.S. industrial tax policy put in place over the last thirty years. And the Treasury plan, in particular, deliberately would shift a heavier tax burden to the corporate sector. The cost of investment capital probably would increase under all these plans. Because of the Treasury plan’s full scale extension of inflationInflation is when the general price of goods and services increases across the economy, reducing the purchasing power of a currency and the value of certain assets. The same paycheck covers less goods, services, and bills. It is sometimes referred to as a “hidden tax,” as it leaves taxpayers less well-off due to higher costs and “bracket creep,” while increasing the government’s spending power. indexing to depreciationDepreciation is a measurement of the “useful life” of a business asset, such as machinery or a factory, to determine the multiyear period over which the cost of that asset can be deducted from taxable income. Instead of allowing businesses to deduct the cost of investments immediately (i.e., full expensing), depreciation requires deductions to be taken over time, reducing their value and discouraging investment. , capital gains, and debt, its potential impact on investment decisions and the economy would depend to a large extent on future inflation rates — and expectations as to future inflation . For savings and investment incentives, lower marginal rates would help offset the loss of the Accelerated Cost RecoveryCost recovery is the ability of businesses to recover (deduct) the costs of their investments. It plays an important role in defining a business’ tax base and can impact investment decisions. When businesses cannot fully deduct capital expenditures, they spend less on capital, which reduces worker’s productivity and wages. System and/or the investment credit. But no present econometric framework can capture all of the trade-offs and interactions of the proposed reforms. The net results for economic efficiency are unknown, and the attendant uncertainties about such a drastic change in industrial tax policy may lead to modification of the reform plans.

The Treasury plan above all emphasizes neutrality of tax treatment between income groups of individuals and among industries and investments. The drive for base-broadening neutrality appears to control the agenda of reform although it is not exclusive of political considerations, such as the proposed doubling of the personal exemption and retaining the basic mortgage interest deductionThe mortgage interest deduction is an itemized deduction for interest paid on home mortgages. It reduces households’ taxable incomes and, consequently, their total taxes paid. The Tax Cuts and Jobs Act (TCJA) reduced the amount of principal and limited the types of loans that qualify for the deduction. for individuals. In a number of cases the neutrality objective raises new questions of equity as in the proposed elimination of deductions for state/local taxes and in the interaction between proposed treatment of capital gains and state income taxes.

What will happen to these ambitious tax reform plans in the 99th Congress is very much up for grabs. It will take a disciplined effort on the part of the Administration, the congressional tax-writing committees, and Congress as a whole to put through anything close to the Treasury reform plan or the Bradley-Gephardt or Kemp-Kasten programs. It’s far from certain that any such effort will be made even though there is a strong public interest in and desire for tax simplification and reform.

It is unfortunate that the most extensive tax reform consideration in at least thirty years is taking place in the context of the severest budget deficit problem ever. Elegant plans of the reformers could be emasculated quickly in the current environment. If the budget process turns to raising new taxes by combing through the agenda of reform, as has already been hinted by some, hope for a really simplified system could be dashed. Another round of TEFRA-type nickel and dime base broadeningBase broadening is the expansion of the amount of economic activity subject to tax, usually by eliminating exemptions, exclusions, deductions, credits, and other preferences. Narrow tax bases are non-neutral, favoring one product or industry over another, and can undermine revenue stability. with little or no rate reduction or other relief could be a fatal setback to the cause of reform. It is no coincidence that those who are sincerely interested in improving the system strongly want to keep tax reform and the budget deficit apart. They must succeed in this for any real reform to have a chance.