Tax Plan: So Many Stand to Gain

My Uncle Harold called last night. “What’s going on in Washington,” he wanted to know.

“Oh, the usual assortment of mischief,” I replied. “What did you have in mind?”

“The tax bill, of course,” he insisted.

“Oh, that. Great, isn’t it?,” I answered, revealing my admiration for the new tax proposal brought forth by Sen. Robert Packwood (R-Ore.)

“Weren’t you telling me just a few days ago that tax reform was dead and that the whole Senate Finance Committee should be sent to Chernobyl?”

“Yes,” I admitted, “that’s the way it looked. The committee was gleefully offering the federal treasury to every lobbyist. Then Packwood did a complete about face. Somehow, he turned good policy into good politics. The proposal reduces tax distortions, removes 6 million poor people from the tax roles and makes the tax code fairer. I am delighted to eat my earlier words.”

“How’d he do it?,” my uncle inquired.

“The key was holding the reform package together as a unified whole,” I replied, “rather than letting it get picked apart piece by piece. And the key to that was getting the committee to balance any proposed revenue loser with a revenue gainer. When the senators had to pay explicitly for their beloved gimmicks, most of the loopholes lost their allure. That is one main idea behind tax reform: you buy lower rates for everyone by selling out the special interests.”

“Are the cuts really as deep as they say?,” asked Uncle Harold.

“Don’t think of this as a tax cut,” I answered. “Together, all Americans pay all the taxes. A revenue neutral bill can’t cut total taxes.”

“Then what’s this business about lower rates for everyone?” a puzzled Uncle Harold inquired.

“You have to distinguish between average tax rates and marginal tax rates,” I answered, thinking how pedantic that sounded. “Tax reform is not about cutting average tax rates but about improving the structure of the tax system so that marginal rates can be lower.”

“How do they do that?”

“By broadening the base. The Packwood proposal does this in several ways. It eliminates many itemized deductions. It taxes capital gains like ordinary income, thereby closing many loopholes. It hits tax shelters (other than oil and gas) from several directions, including disallowing tax losses on limited partnerships. Those forms you get from your partnerships, the ones you use to reduce your tax bill, will be a thing of the past if the bill passes.”

“Too bad,” my uncle mused. “But I always felt a little sleazy when I invested in those deals. I’d just as soon do without them as long as others can’t use them either.”

“Most people feel that way,” I responded. “And more than fairness is at stake. You know, it harms the national economy when tax-conscious investors put their money into unproductive investments that lose money before tax but earn money after tax. Besides, the Internal Revenue Service will compensate you for the loss of your shelters by lowering your marginal rate from 45% to 32%.” (Uncle Harold was no pauper.)

“Wait a minute. The newspaper says the top rate is 27%.”

“That’s true at the top,” I explained. “But modestly rich people like you will face a 32% rate.”

“Why’s that?”

“Because personal exemptions and the advantage of having your first $29,000 taxed at a 15% rate are phased out for families earning between $75,000 and $185,000. That figures to roughly an extra 5% tax over this range. Above $185,000, the marginal rate reverts to 27%.”

“It should happen to me,” Harold mumbled.

“Despite this oddity,” I continued, “a top rate of 32% is quite an achievement. And most Americans will be in the 15% or 27% brackets. Such low rates should encourage people to make productive use of their time rather than avoid and evade taxes. And families of four with incomes below $13,000 will pay no tax at all.”

“What about the corporate tax? How can a drop in the top corporate rate from 46% to 33% be a big tax hike?”

“Well, the investment tax credit is eliminated, which also helps equalize tax rates on different types of investment. More revenue comes from such things as tighter depreciation rules for real estate, tougher accounting procedures and a stiff minimum tax.”

“I thought you didn’t like the minimum tax,” my uncle interjected.

“I don’t. On the one hand, Congress offers a basketful of tax gimmicks ostensibly designed to encourage activities deemed meritorious. But if a corporation engages in too many of these laudable activities, it gets zapped by the minimum tax. I prefer the approach of Treasury I, which was to define income properly and tax it. But, if a minimum tax is the only way we can cut down on abuses, I’ll support it.”

“So you like the Packwood proposal,” Harold summarized.

“So should the American people,” I replied. “Never have so many stood to gain so much at the expense of so few.”