Commission Tax Plans Would Reshape American Economy
Policy + Politics

Commission Tax Plans Would Reshape American Economy

The dramatic tax overhaul contemplated by the co-chairmen of President Obama’s bipartisan fiscal commission  would reshape the economic landscape by withdrawing tax subsidies that have served as cornerstones for some of America’s largest and most influential industries.

Huge swaths of the economy – housing, health care, and energy, in particular — would see their tax subsidies shrink or disappear, while wealthy investors would see higher rates on dividends and long-term capital gains. In exchange, there would be lower tax rates for all businesses — a windfall for highly profitable high-tech businesses like Google that receive no subsidies — but tax increases on those whose subsidies outweigh the benefits of lower rates, such as the U.S. auto industry.

The same dynamic could apply to many middle-income taxpayers: lower taxes for some but higher for others, which is something both parties have vowed to avoid. If the business tax changes proposed by Democrat Erskine Bowles and Republican Alan Simpson, the commission’s co-chairmen, ever made it past the army of K Street lobbyists who storm Capitol Hill to defend their clients’ interests, the jobs, incomes and household balance sheets of tens of millions of Americans would be altered in ways far more profound than anything contemplated in either the health care or financial services reform bills that were recently signed into law, according to industry and tax experts.

“It would hurt some industries which have been
subsidized, generally inappropriately, for decades.”

“It would hurt some industries which have been subsidized, generally inappropriately, for decades,” said Laurence Kotlikoff, an economics professor at Boston University who personally favors scrapping the income tax in favor of consumption taxes. “But if we are to retain the current system, making the proposed changes to the corporate tax would be a very major improvement.”

The chairmen’s outline released on Wednesday contained three options for changing the federal tax code. Their goal was to raise about $960 billion or about a quarter of the deficit reduction included in their $3.8 trillion plan for the coming decade. The rest would come in spending cuts, including changes to Social Security and Medicare and cutbacks in defense programs.

Their simplest and most radical proposal was scrapping all the subsidies  in the income tax code. The largest of those are the exclusion of health benefits from income taxation ($94.4 billion in 2009, according to the Joint Committee on Taxation), the home mortgage deduction ($86.4 billion), and the subsidies for defined benefit and defined contribution retirement plans ($73 billion). The trade-off would lower income tax rates for individuals currently from 10 to 35 percent to 8 to 23 percent, while the corporate tax rate would decline to 26 percent from 35 percent — more in line with other developed countries.

While the commission chairmen provided no breakdown on how the changes would affect individual taxpayers, experts say removing those subsidies would transform the fundamentals of industries that provide key elements of middle-class wealth and well-being — housing, financial services and health insurance.

Shorn of the mortgage deduction, housing prices would probably take another dip. The market for second homes among wealthier Americans would probably be curtailed, and the average size of new homes, which has been growing for decades, would probably shrink.

“The mortgage interest deduction is one of the
pillars of our housing policy, and limiting its use will
have negative repercussions up and down the housing

Major housing trade groups slammed the proposal shortly after its release. “Diminishing or ending the deduction would exert further downward pressure on home prices,” the National Association of Home Builders said in a statement. The Mortgage Bankers Association added that “The mortgage interest deduction is one of the pillars of our national housing policy, and limiting its use will have negative repercussions for consumers and home values up and down the housing chain.”

Similarly, removing tax incentives for retirement savings in an era when most companies have gotten rid of their defined benefit pension plans would probably reduce the ability of the middle class to save for retirement. It would also likely reduce their willingness to invest those “after tax” savings in the stock market.

Ending the health care benefit exclusion would have the most immediate and dramatic impact. If it were done prior to implementation of the state-based health care reform exchanges that are slated to go into effect in 2014 under the new health care reform law: , it would result in an increase in the uninsured of 8 to 10 million people, according to Jonathan Gruber, a health care economist at the Massachusetts Institute of Technology who helped design both the Massachusetts and U.S. reform laws.

“There is no health economist who would set up a new health system with such tax exclusion in place,” he said, but “we are wary of getting rid of it in today’s marketplace given the fact that it would mean throwing many individuals into the harsh non-group market.”

Ending the exclusion would render inoperative one
of President Obama’s core promises in health care
reform: that most people will be able to “keep what
they have.”

David Cutler, a health care economist at Harvard who worked with the Obama administration on health care reform, agreed that removal of the health benefit tax exclusion would likely result in many employers dropping group coverage and providing their workers with cash subsidies to go out and purchase their own plans on the state-based exchanges. In other words, ending the exclusion would render inoperative one of President Obama’s core promises in pushing health care reform: that most people will be able to “keep what they have.”

“Yes there would be additional erosion” if there was total repeal, said Gruber. But “once we have a non-discriminatory and well-functioning non-group market, we don’t need this expensive, regressive and inefficient subsidy anymore.”

The fiscal commission co-chairmen included less dramatic alternatives such as partially eliminating the tax code subsidies. They also offered the option of adopting tax reform proposals authored by Sen. Judd Gregg, R-N.H., a member of the commission, and Sen. Ron Wyden, D-Ore.

Their plan would leave some corporate income tax breaks intact — it would make the research and development tax credit permanent, for instance — but would remove a number of broad business tax exclusions that lower reportable income, such as last-in-first-out inventory accounting rules; a tax credit favoring domestic production, and preferential depreciation rules.

They also would remove the special subsidies for the oil and gas industries, a favorite target of Congressional liberals that were included in the president’s ill-fated energy plan. They include the oil depletion allowance and special subsidies for drilling and developing new oil wells in hard-to-reach places.

“This would reduce U.S. oil production by less than one percent,” said Gilbert Metcalf, an economist at Tufts University who focuses on the energy industry. “These are drilling programs that are only profitable because of the subsidies (and) are excellent targets for deficit reduction.”

Bowles and Simpson didn’t go far enough in using the tax code to redraw the energy sector, Metcalf said. For instance, in calling for an increase in the gasoline tax to 33 cents from 18 cents where it has been since 1992, they were only restoring its inflation-adjusted value to where it was two decades ago. They also didn’t include an inflation-adjustment factor for the future, and ignored the 30 percent of oil consumption that doesn’t go into automobiles and trucks.

Metcalf also questioned the absence of a carbon tax, which while controversial, could raise as much as $100 billion a year and make a major contribution to reducing greenhouse gases by encouraging a shift to energy alternatives. “My recommendation to the commission, which they ignored, was to phase it in and give it back to households in rebates to start, but shift away over 10 years in order to use revenue to lower the deficit,” he said.