When I think of income tax reform, I think big. I think of massive elimination of tax deductions, with great big rate reductions as consolation for taxpayers that lose their breaks. I look for elimination of alternative ways of tracking income and deductions, with the idea that one way that everyone can understand is better than special breaks for different industries. I look to eliminate double taxation of income everywhere, including elimination of capital gain taxes and integration of the corporate and individual systems.
By these standards, the tax reform plan put forth by Dave Camp, the chairman of the House Ways and Means Committee, is a disappointment. While it would make many simplifying changes to the tax law while rates, it would leave behind a system that would still be very recognizable to a Rip Van Taxman who fell asleep in 1993. It prunes tax complexity, but it doesn’t begin to clear the forest.
Still, politics being what it is, trimming the weed sanctuary is probably the best we can expect. Maybe better than we can expect.
Tony Nitti has already posted detailed walk-throughs of the individual and business parts of the proposal, so there’s no point in me repeating his work. Instead I will list some of the bigger changes proposed, with my commentary. I don’t expect anything like the Camp plan to be enacted during the current administration, but I think it gives us an idea of the kinds of changes that could happen after 2016, if the stars align.
Individual Rates. The bill would have a three-bracket tax system: 10%, 25%, and 35%. The 35% bracket would replace the current 39.6% bracket, and would only apply to income other than “qualifying domestic manufacturing income.” Lowering rates is fine, but this would retain the stupid difference between manufacturing income and other income embodied in the current Section 199 deduction. It’s a complex and economically illiterate break for a favored class of income paid for by higher rates on all other income.
Capital gains and dividends would be taxed as ordinary income, but only after a 40% exclusion. That would be a 21% net rate on 35% taxable income. (Initially I said 14%, math is hard).
Deductions would be trimmed back. The maximum home mortgage interest debt allowed for deductions would be $500,000, instead of the current $1.1 million. Medical deductions would go away. Standard deductions would increase to $11,000 for individuals and $22,000 for joint filers. Many itemized deductions would reduce taxes only at the 25% rate, rather than the 35% top rate. Charitable deductions would be simplified, but only deductible to the extent they exceed 2% of AGI. The deduction for state and local taxes would be eliminated.
The increase in the standard deduction is an excellent idea. I’m fine with reducing the mortgage interest deduction. The limiting of deductions to the 25% rate is pointless revenue-raising complexity. The elimination of the medical deduction will be a real burden on people in skilled nursing care; they are the people who generally can take this deduction. Taxing them while they burn through their assets paying nursing home costs will only put them into title 19 that much sooner.
While I am sympathetic with the policy reasons for not allowing a deduction for state and local taxes, those reasons don’t apply to taxes arising from pass-through business income. State taxes are a cost of doing business for those folks, and should be deductible accordingly.
Alternative Minimum Tax would go away. About time.
Corporate rates. The proposal replaces the current multi-rate corporate tax with a flat 25% rate. Excellent idea, as far as it goes, but it is flawed by the 35% individual top rate; it provides a motivation to game income between the individual and corporate system.
The proposal eliminates a number of energy credits while retaining the research credit. I think that it would be better to get rid of the research credit and lower rates. I think the IRS is no more capable of identifying and rewarding research than it is of fairly administering political distinctions. Unfortunately, the credit seems to be a sacred cow among taxwriters.
Incredibly, the Camp corporate system gets rid of the Section 199 deduction while retaining a similar concept for individual rates. Here it doesn’t get rid of pointless and economically foolish complexity; it just moves it around in the code.
LIFO inventories go away under the proposal. As this comes up every proposal, it’s going to happen sometime.
Carried interests become taxable as ordinary income. This is more complexity, apparently a sop to populist rhetoric.
Pass-throughs would be tweaked. S corporation elections would be easier to make, and could be delayed until return time. Built-in gains would only be taxable in the first five years after an S corporation election, instead of ten years. Basis adjustments on partnership interest transactions would be mandatory, instead of elective.
Fixed assets would have mixed treatment. While the Secti0n 179 deduction would permanently go to $250,000, depreciation would go to a system more like the pre-1986 ACRS system than the current MACRS system.
Cash basis accounting would be more widely available, and fully available to Farmers and sole proprietors. This is a step in the wrong direction. Advocates of cash accounting say that it provides “simplicity,” implying that poor farmers just can’t handle inventory accounting. Meanwhile these “poor” bumpkins play this system like a fiddle, manipulating cash method accounting to achieve results that are only available through fraud to the rest of us. Modern farm operations with GPS, custom planting and nutrient plans, and multi-million dollar asset bases are as able to handle accrual accounting as any other business of similar size.
There’s plenty more to the plan, but you get the idea. I find it disappointing that they don’t replace the current system of C and S corporations with a single system with full dividend deductibility. I find the treatment of preferences and tax credit subsidies half-hearted. I think there should be fewer deductions, fewer credits, and a much bigger standard deduction. That’s why I’d never get elected to anything, I suppose.
The TaxProf rounds up coverage of the proposal. Other coverage:
Paul Neiffer, Tax Reform – Part ?????!!!!! “Since this is a mid-term election year, it has little chance of passing this year, but it is important to note possible changes that Congress is pondering.”
Annette Nellen, Congressman Camp’s Tax Reform Act of 2014 Discussion Draft
Leslie Book, Quick Thoughts on Procedural Aspects of Camp’s Tax Code Overhaul Proposal and the Spate of Important Interest Cases (Procedurally Taxing)
Joseph Thorndike, Democrats and Tax Reform: Can’t Do It With ‘Em, Can’t Do It Without ‘Em (Tax Analysts Blog). ”If you’re a left-leaning populist, what’s not to like? Well, at least one big thing: The bill doesn’t raise taxes.”
Kyle Pomerleau, Andrew Lundeen, The Basics of Chairman Camp’s Tax Reform Plan (Tax Policy Blog). ”We’ll have more analysis on the plan soon – it will take us days to get through the 979 pages of legislative text – but in the meantime, here are the basics.” They note that the plan uses tax benefit phase-outs based on income — a bad idea that creates hidden tax brackets.
Renu Zaretsky, Tax Reform: one foot in front of the other (TaxVox)
William Perez, Last Year’s State Tax Refund Might Be Taxable
Jason Dinesen, Glossary of Tax Terms: Depreciation
Trish McIntire, Brokerage Statements. ”Actually, my problem is clients who don’t bring in the whole statement.”
Jack Townsend, Wow! Ty Warner Is Ty Warner is Not Quite the Innocent Abroad
TaxProf, The IRS Scandal, Day 294. I note that Lois Lerner won’t testify without being immunized from prosecution. ”Not a smidgeon” of wrongdoing, indeed.
Finally, Seven People Who Have a Worse Busy Season Than You, from Going Concern. That’ll cheer you right up.
Tags: Andrew Lundeen, Annette Nellen, Going Concern, Jack Townsend, Janet Novack, Jason Dinesen, Joseph Thorndike, Leslie Book, Paul Neiffer, Peter Reilly, Pyle Pomerleau, Renu Zaretsky, tax reform, TaxGrrrl, TaxProf, Trish McIntire, William Perez