The President's Economic Recovery Advisory Board released its Report on Tax Reform Options Friday — only eight months late.
The PERAB, headed by former Chairman of the Board of Governors of the Federal Reserve Paul Volcker, was created by President Obama back in early 2009. It was charged with considering ways to simplify the tax system, improve taxpayer compliance with existing laws, and reform the corporate tax. The Board’s report was originally scheduled to be presented to the President by Dec. 4, 2009.
Unlike the earlier tax reform panel created by George W Bush in 2005, which was pretty much given carte blanche to investigate and review all options, the scope of President Obama’s panel was restricted by specific instructions from the White House.
As indicated in the Executive Summary of the report issued by George W. Bush’s panel, the only instruction given by the President was to “recommend options that will make the tax code simpler, fairer and more conducive to economic growth.”
However, according to the preface in Friday’s report, Obama’s Board “was not asked to recommend a major overarching tax reform, such as the 1986 tax reform, the tax plans proposed by the 2005 Tax Reform Panel, or proposals for introducing a value-added tax in addition to or in lieu of the current income tax system... consistent with our limited mandate, we did not evaluate competing proposals for overarching tax reform in this report.”
And more specifically, it “asked to exclude options that would raise taxes for families with incomes less than $250,000 a year.”
The report, which covers the three areas it was formed to investigate — simplification, compliance and the corporate tax — begins with the simple, but obvious, statement that “The tax code is complex.” It goes on to explain:
“The complexity of the tax code is partly the result of the fact that new provisions have been added one at a time to achieve a particular policy goal, but with inadequate attention to how they interact with existing provisions. This results in duplicative and overlapping provisions, multiple definitions of concepts like income and dependent children, differences in phase outs, and differences in the timing of expiring provisions. Between 1987 and 2009, the instruction booklets sent to taxpayers for the Form 1040 increased in length from 14 pages to 44 pages of text. The tax code has become more complex and more unstable over the last two decades in part because legislators have increasingly used targeted tax provisions to achieve social policy objectives normally achieved by spending programs. There have been more than 15,000 changes to the tax code since 1986, and a current JCT pamphlet lists 42 pages of expiring provisions.”
Most of the options for simplification concern simplifying and consolidating various similar tax credits and benefits. Here they are.
- Consolidating the dependent exemption, the standard deduction, and the Child Tax Credit into a “Family Credit” available to all taxpayers, replacing the Earned Income Credit and refundable portion of the Child Tax Credit with a “Work Credit,” eliminating the Dependent Care Benefit and replacing tax benefits for higher education with a generous extended “Family Credit” for full time students under age 22.
- Replacing the large number of subsidies that exist to help taxpayers pay for current education expenses with one or two alternatives.
- Simplifying the rules for the “Kiddie Tax,” the method by which investment income of dependent children is currently taxed (established to keep parents from escaping taxes by putting money in their children's names).
- Consolidating all employer sponsored retirement plans into one work-based retirement account, all individual retirement plans into one individual retirement account, and all special purpose savings accounts (i.e. Education Savings Account, Health Savings Account) into one account for non-retirement savings.
- Allowing all workers to contribute to either or both an IRA and an employer-sponsored plan irrespective of income (thereby eliminating nondeductible IRAs).
- Requiring the use of the Average Cost Method to determine cost basis for the sale of all mutual fund shares.
- Eliminating the Alternative Minimum Tax. For those unfamiliar with the AMT, it is an alternative tax system that was originally established to make sure high-income individuals do not use tax shelters and loopholes to avoid paying their share of federal income tax, but under current law causes many unintended victims to pay a higher tax than under the “regular” tax system.
For a tax professional like myself who has been in the business since the 1970s it was déjà vu all over again. One option presented in the report was replacing the various capital gain tax rates with a 50% capital gain exclusion.
Many of the options discussed in the report are either similar to or the same as recommendations of President Bush’s earlier panel, and the report so states, or are a restating of other familiar proposals.
The topic of compliance begins the report, with the panel reporitng that taxpaers pay about 83.7% of taxes on time. Here, the report points out what many tax professionals, myself included, have been saying for years.
“One theme we heard repeatedly was that voluntary compliance would be increased by having a simpler, more transparent and more easily understood tax system, and from stable and consistent tax law. The complexity of the current tax code results directly in involuntary errors and facilitates intentional evasion.”
Like the options listed for simplifying the Tax Code, those for compliance, with one exception, are also nothing new:
- Dedicate more resources to enforcement and enhance enforcement tools.
- Clarify the definition of an independent contractor.
- Increase information reporting and source withholding (mostly more third-party 1099s).
- Increase voluntary disclosure programs.
- Require all partners, LLC members, and S corporation shareholders who materially participate in the entity’s business to pay self-employment tax on business distributions.
One new option discussed would require all small businesses “to use a designated bank account for all business receipts and expenditures that is segregated from any personal bank account. The bank would be required to report the receipts and expenditures within the designated account annually.”
The “Report on Tax Reform Options” issued by the President’s Economic Recovery Advisory Board does an excellent job of identifying the problems with our current tax system. Hopefully it’s suggestions will be used as the starting point for a serious discussion of tax reform by Congress and the Administration, and it is and not just filed away somewhere for posterity .
In a letter to the Treasury Secretary the committee said, "The effort to reform the tax code is noble in its purpose, but it requires political willpower." Perhaps this was a reference to the fact that the recommendations of George W Bush’s tax reform panel were totally ignored.
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