The Tax Side of the Fiscal Commission's Draft Proposal

With the White House fiscal commission Co-Chair's proposal out in public, it's time to continue looking at the specifics of the plan. For this blog, we will look at the tax proposals.

Right now, revenue sits at an unusually low 14.6 percent of GDP due to the effects of the recession. Under the tax proposals, revenue would rise to 19.3 percent by 2015, 20.5 percent by 2020, and 21 percent by 2030. Revenue is capped at 21 percent so it does not go higher than that. Over the next decade, the proposal would increase revenue by about $1 trillion.

Bowles and Simpson present three different possibilities for revenue-raising tax reform: a "clean slate" option, Wyden-Gregg-esque reform, and a tax reform trigger. The goal of each of these three options is to raise $80 billion in 2015.

The clean slate option is a simple one. At its simplest, the clean slate:

• eliminates all tax expenditures
• consolidates the income tax into three rates
• reduces the corporate tax rate
• eliminates the AMT
• eliminates the Pease limitation on itemized deductions and the personal exemption phase-out (PEP) for higher income taxpayers (these are currently repealed but would come back if the upper-income tax cuts expire)

The proposal also presents what the four rates (three income, one corporate) could be if certain tax expenditures were added back in while still raising the same amount of revenue. Those options are presented below.

The chart is a great illustration of how tax expenditures force marginal tax rates up.  Of course, adding back in the mortgage, health, and retirement tax breaks force marginal rates up the most, since those are the largest--and the most distortionary--tax expenditures in the tax code. That's why cleaning up these benefits especially is important for creating a more economically sound tax system.

The second option for tax reform is a Wyden-Gregg type effort. Similar to the tax reform legislation sponsored by senators Ron Wyden (D-OR) and Judd Gregg (R-NH), it would

• reduce the income tax to three brackets (15/25/35)
• triple the standard deduction to $30,000
• repeal the AMT, PEP, and Pease
• go after a wide variety of tax expenditures
• reduce the corporate tax rate to 26 percent while eliminating or reforming many business carve-outs (like oil and gas preferences)

However, the Simpson and Bowles go farther than Wyden-Gregg on the largest tax expenditures. Specifically, they would:

• Repeal the state and local tax deduction;
• Limit the mortgage interest deduction to first residences and lower the cap on mortgages from $1.1 million to $500,000;
• Put a floor on charitable deductions at two percent of adjusted gross income;
• Cap the exclusion for employer-provided healthcare.

By going after the biggest tax expenditures and by having a slightly higher corporate rate, the Co-Chairs ensure that this option raises more revenue than the Wyden-Gregg plan.

The final option is more of an "in case of emergency, pull here" option: the tax reform trigger. Under this option, if comprehensive tax reform is not enacted by the end of 2012, it would trigger an across-the-board reduction in itemized deductions, the employer health exclusion, and general business credits. By their rough estimate, this would require a 15 percent reduction by 2015 in order to raise the requisite $80 billion in revenue. The reduction would increase over time so that either lawmakers would be pressured to enact tax reform or tax expenditures would be phased out automatically.

The plan recommends two other tax changes besides tax reform: increasing the gas tax by fifteen cents and switching to the chained CPI, a move that would be implemented government-wide and would affect both sides of the budget. The gas tax idea was recommended earlier this week by senators George Voinovich (R-OH) and Tom Carper (D-DE) as a way to shore up the highway trust fund and invest more money into our nation's infrastructure. 

The combination of fundamental tax reform (in one of the three forms), the gas tax increase, and switching to the chained CPI raises $1 trillion in revenue over nine years.

CRFB commends the Fiscal Commission for coming out with such specific and sustainable revenue provisions for helping to deal with our fiscal challenges.