The president’s deficit reduction panel issued a draft proposal last week that has virtually everyone up in arms. The proposal would savage seniors, decimate the housing market, bankrupt charities and make Americans poorer in retirement — at least if you believe what the various special interest groups are saying.
However, some accountants and tax specialists say that the impact of at least the tax portion of the proposal is far less draconian than advertised. Some say it could even help the economy by eliminating gamesmanship that’s spurred by high rates and copious loopholes.
But there would clearly be winners, and losers. And the biggest losers, according to a special TFT analysis, are likely to be the very folks whom politicians have catered to most: middle class families with children who own their homes and save for their retirement. By contrast, under some proposals, the wealthy come out ahead. That could make passing such reforms challenging — in spite of other potential rewards, including simplicity, efficiency and revenue raising power.
“If somebody waived a magic wand and this was suddenly passed, we would have higher taxes,” said Bill Ahern, spokesman for the Tax Foundation in Washington, D.C. “But the efficiency gains you would get from taking away all the loopholes are so great that we think the plan deserves serious attention. This is mother’s milk to fundamental reformers.”
a tax return on a postcard, though potentially a large one.”
A professional analysis of the draft proposal commissioned by The Fiscal Times found the Simpson-Bowles plan would hike taxes on some individuals, but cause other taxpayers to pay less. That’s because the draft eliminates loopholes, but drastically lowers rates. That would mean that more people would pay taxes, but the pain would be distributed far more evenly than it is today, according to the analysis by the Santa Monica tax accounting firm of Holthouse Carlin & Van Trigt.
People who are unable to take advantage of today’s breaks — childless renters, for example — would benefit greatly from tax reform, noted Philip J. Holthouse, the Santa Monica tax attorney who conducted the analysis. Seniors might benefit too, depending on which reform gathers support. And everyone could enjoy the simplicity of being able to file a tax return on a postcard (though potentially a large one) when the confusing cacophony of deductions and credits that befuddle so many taxpayers are nixed.
“Do not underestimate the hidden potential benefit of having many people spend a lot less time and energy on trying to minimize their taxes under the current system,” said Holthouse.
The Different Faces of Reform
But determining exactly how the plan could affect you is a bit tricky. That’s because the Simpson-Bowles deficit reduction draft actually includes several different tax reform options. One option, called the "Zero" plan eliminates every deduction and credit that’s allowed in current tax law while dramatically slashing rates. Under "Zero," progressive rates * drop from 15 percent to 8 percent; from 28 percent to 14 percent; and from 39.6 percent to a top rate of 23 percent.
All of the other reforms suggested in the Simpson-Bowles draft proposal would add back some popular breaks including the earned income tax credit, the child tax credit, a limited home interest deduction and breaks for contributing to retirement plans. But these modified reform proposals — the least drastic of which is called the Wyden-Gregg plan — would cut tax rates far more modestly. Wyden-Gregg, which proposes rates of 15 percent, 25 percent and 35 percent, would also significantly boost the standard deduction, helping any taxpayer who currently doesn’t itemize.
|Official IRS Tax Rate Schedule Updates for Tax Year 2010|
|Tax Bracket||Single||Married Filing Jointly|
|10% Bracket||$0 – $8,375||$0 – $16,750|
|10% Bracket||$8,375 – $34,000||$16,750 – $68,000|
|25% Bracket||$34,000 – $82,400||$68,000 – $137,300|
|28% Bracket||$82,400 – $171,850||$137,300 – $209,250|
|33% Bracket||$171,850 – $373,650||$209,250 – $373,650|
|Additional tax brackets are available at Moneychimp.com|
Who Wins? Who Loses?
To illustrate the range of possibilities, Holthouse Carlin & Van Trigt examined a group of hypothetical families, representing seniors, renters, parents of small (and grown) children, as well as high-income filers with substantial income from various sources — wages, dividends, capital gains and even tax-free municipal bond interest.
families who reap substantial breaks from current law."
The analysis found that the Wyden-Gregg plan would cut taxes for the two hypothetical taxpayers who earned the least, while the “zero” option would cut rates for three taxpayers — the poorest and the two wealthiest.
Hit hardest by the proposals were middle-income families who reap substantial breaks from current law because they get big credits for having small children, big mortgages and use tax-favored accounts to save for retirement and child care.
“The current tax system is very policy-driven,” said Clint Stretch, director of tax policy with Deloitte & Touche in Washington, D.C. “It says that children are an expense that the government ought to help you with and being married is better than being single.
“But one of the bombs in that system is that you pay more when you pay off your mortgage or when your kids grow up,” he said. “Heaven forbid you have triplets who all turn 17 at the same time. Your tax rate would double.”
Bible and requires 71,684 pages to spell out the rules.
Under the current system taxpayers with identical income can end up paying vastly disparate amounts depending on whether or not they can take advantage of the most generous credits and deductions written into today’s tax code. In a nutshell, families with big houses and small children now pay far less than taxpayers who rent their homes — or pay off the loans.
Have a sideline business, kids in college or a big retirement plan? The current tax code loves you, offering a series of breaks to choose from, said Mark Luscombe, principal tax analyst with Riverwoods, Ill.-based CCH, a publisher of tax information. But you’ll feel less loved if you avoid debt and are withdrawing money from a retirement plan, rather than funding it.
The Power of Simplification
Many experts believe that tax breaks that favor different groups in today’s code undermine compliance and provide a compelling argument for reform. They also make filing a nightmare. Where the tax code could have been published in single 400-page book when income taxes were established in 1913, today’s tax code is several volumes longer than the Bible and requires 71,684 pages to spell out the rules.
“A dramatic simplification like this would boost faith in the fairness of the system and make people more willing — and more able — to comply,” said Ahern. “The beauty of this proposal is that it gores every sacred cow in the herd. That’s got the special interest groups drowning each other out trying to denounce it.”
That said, virtually no one expects any of these drafts to be passed exactly as proposed. The proposal is more of a starting point for the discussion than a formal plan. “This is a discussion opener that says the way to think about reform is to go with lower rates and a broader base. This is an important conceptual statement,” said Deloitte’s Stretch.
As for the din from detractors, Stretch shrugs: “There’s no way to raise $1 trillion in tax revenue and have everyone say, ‘Oh, yeah. That’s a good idea.’ Someone is going to have to pay more and they’re not going to like it.”
How much could you be affected by the sweeping tax reforms proposed by the President’s deficit reduction panel? We asked the Santa Monica tax law and accounting firm of Holthouse Carlin & Van Trigt to examine the impact of the most aggressive and least aggressive of the proposals on a variety of hypothetical families. To make the examples as accurate as possible, the tax firm assumed that each family would have deductions and credits appropriate for their circumstances –those with mortgages not only paid tax-deductible interest, but had property and state income tax write-offs as well. Here are the results:* - Kathy KristofSenior Couple: $65,000
Income is made up of $25,000 from Social Security (almost half of which is tax free under current law) and $40,000 from pensions and 401(k) plan withdrawals. They own a home and pay $3,000 in property taxes, but have no mortgage. Their other itemized deduction under current law is $1,500 in annual contributions to charity.
Tax under current law: $4,194
Tax under “zero option” reform: $4,616
Tax under Wyden-Gregg reform: $2,389
Single renter: $50,000
All income comes from wages. This taxpayer has no children and rents a home. His only deduction is the $5,000 that he contributes to his 401(k).
Tax under current law: $4,706
Tax under “zero option” reform: $4,449
Tax under Wyden-Gregg reform: $3,953
Single parent: $85,000
This taxpayer has one child, age 8, who allows her to qualify for a $1,000 child tax credit under current law. She contributes $5,000 to a workplace retirement plan and $5,000 to a dependent care account, reducing her taxable income to $75,000. She also owns a home, paying $10,000 in mortgage interest, and gives $1,000 annually to charity.
Tax under current law: $7,034
Tax under “zero option” reform: $8,145
Tax under Wyden-Gregg reform: $8,871
Married Parents: $130,000
This married couple has two children, ages 5 and 7, earn $125,000 in wages and $5,000 from capital gains and dividends. They contribute $10,000 to 401(k) plans; $5,000 to a dependent care account; deduct $20,000 in mortgage interest; and give $3,000 to charity. Current law also gives them a big break – the child tax credit – for having small children.
Tax under current law: $6,641
Tax under “zero option” reform: $12,076
Tax under Wyden-Gregg reform: $10,300
High-income Parents: $200,000
This couple has two grown children, ages 18 and 20, who are both in college, but they don’t qualify for the American Opportunity Tax Credits that would normally lower their tax bill by $5,000, because they earn too much. They contribute $20,000 to workplace retirement plans; deduct $30,000 in mortgage interest; and give $5,000 annually to charity.
Tax under current law: $21,449
Tax under “zero option” plan: $21,876
Tax under Wyden-Gregg plan: $25,450
Wealthy Empty-Nesters: $525,000
This couple earns $475,000 in salary; $10,000 in dividends; $15,000 from currently tax-free municipal bond interest; and $25,000 annually from capital gain income. Their deductions: $50,000 on mortgage interest; $25,000 to charity; as well as state income and property taxes.
Tax under current law: $113,750Tax under “zero option” plan: $96,159
Tax under Wyden-Gregg plan: $131,491
Millionaire Couple: $1,060,000
They’ve got $1 million in salary; another $60,000 from capital gains and dividends. Write off $50,000 in mortgage interest; give $50,000 to charity; and pay income and property taxes.
Tax under current law: $258,740
Tax under “zero option” plan: $219,209
Tax under Wyden-Gregg plan: $316,291
Source: Holthouse Carlin & Van Trigt, Santa Monica
*Based on 2010 tax schedules that are slightly inflation-adjusted from those published here at IRS.gov .