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We Ordered Tax Reform, But Congress Delivered a Pu Pu Platter Instead

Kevin McGrath contributed to this post.

Most Americans are content to finally be done with their tax returns. The Senate and House, on the other hand, are back in session and engaging in political showdowns on tax law. Each chamber considered a separate bill on tax policy this week, and they both fell squarely along the partisan lines that we have come to expect for this election year.

Senate Democrats proposed a change that has become known as the “Buffett Rule,” named after billionaire investor Warren Buffett, who admitted to paying a lower effective tax rate than his secretary. The proposal was a highlight of President Obama’s State of the Union address and, although the bill failed to proceed in the Senate on Monday, the underlying principle remains a campaign plank of the Democratic Party heading into this fall’s elections.

The present federal income tax code contains many preferences that disproportionately benefit high-income individuals and enable them to pay lower effective tax rates than others with less income. Foremost among these preferences are the special rates for long-term capital gains and qualified dividends, which comprise substantial portions of the taxable income of many upper-income individuals.

The Alternative Minimum Tax (AMT) was enacted some time ago to address this type of problem. Len Burman, a member of the Bipartisan Policy Center’s (BPC) Domenici-Rivlin Task Force, wrote in Monday’s New York Times that the minimum tax “was intended to make sure that rich people did not embarrass Congress by taking too much advantage of the tax loopholes that it had created.” Unfortunately, the AMT also produced unintended consequences – including a much more complex tax code – and in spite of it, the effective tax rate issue has persisted.

BPC’s plan to create a simpler, pro-growth tax system

Enter the Buffett Rule, which would ensure that individuals earning over $2,000,000 pay at least 30 percent of their income in taxes. The statute would have a phase in between $1-2 million (detailed here by the Committee for a Responsible Federal Budget), but generally, taxpayers with incomes greater than $2,000,000 and a tax liability of less than 30 percent would be charged the difference. The Joint Committee on Taxation estimated that implementing the Buffett Rule would raise $46.7 billion dollars over the next 10 years, assuming the expiration of the “Bush” tax cuts on high earners. (Alternatively, from a baseline that extends the reduced top rate of 35 percent, revenue raised from the policy would increase to an amount greater than $100 billion over the decade.)

The Buffett Rule would increase the progressivity of the tax code and would raise some revenue to reduce the federal deficit, but economists on both sides of the aisle agree that these goals could be accomplished in more efficient ways. As Howard Gleckman of the Tax Policy Center put it, “imposing a minimum tax of any kind is an admission of policy failure.” The Rule effectively acknowledges that the current code is not producing desired outcomes, and this policy would add yet another layer of further distortion and complication to the system.

The Republican-led House, in contrast, just passed a tax deduction for businesses with less than 500 employees. The bill would allow these businesses to deduct 20 percent of their incomes from taxation next year. Supporters claim that the tax break would spur growth, and House Majority Leader Eric Cantor’s office suggests that it would benefit 22 million small businesses. The deduction is projected to cost the federal government $46 billion in forgone revenue for 2013.

Much like the Buffet Rule, there are attractive elements to this proposal: the tax cut could have positive short-term economic impacts and it temporarily would reduce marginal tax rates for some businesses. Both of these objectives, however, could be better addressed through large-scale tax reform.

The main purpose of these exercises was to further define partisan battle lines and draw ideological contrasts that will be useful for the general election. The American public, however, would be far better off if both parties worked together to make the tax code simpler, more efficient, more progressive, and more pro-growth, while raising the revenue necessary to help control our debt.

Comprehensive tax reform plans such as those proposed by BPC’s Domenici-Rivlin Task Force and the Bowles-Simpson Commission would increase progressivity by reforming tax preferences and provide a boost to small businesses by lowering corporate and individual rates (under which most small businesses file). In other words, both parties can get what they claim to want, but only if they actually come to the table on a bipartisan tax reform framework.

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