January 2007 Monthly Luncheon
"“Tax Reform, Tax Credits and the Taxation of Capital”
Review of Remarks by Ike Brannon
By Andrew Bershadker
On January 18, 2007 the SGE monthly luncheon was pleased to have Ike Brannon as a speaker on tax credits, capital taxation, and their relation to tax reform. Since 2005, Dr. Brannon has served as the Principal Economic Adviser to Senator Orrin Hatch, advising the Senator on issues pertinent to taxation and the Senate Finance Committee. He previously served the Congress as the chief economist for the Joint Economic Committee. His research generally focuses on issues of trade, pensions, energy and transportation.
Dr. Brannon began his talk by discussing the prospects for tax reform in the 110th Congress, spanning 2007 and 2008. He feels that despite the recent discussions of tax reform and the November 2005 study published by the President’s Advisory Panel on Tax Reform, the prospects for tax reform in 2007 or 2008 are slim. The 110th Congress is more likely to focus on efforts to close the “tax gap” (the difference between the amounts taxpayers owe and the amounts actually collected), tax exempt organizations, health care, and possibly Social Security reform. Tax reform is much more likely to be seriously considered in 2009 and 2010, regardless of which party controls Congress.
Dr. Brannon suggested three reasons for 2009 and 2010 being crucial years. The first reason is the growing cost of the Alternative Minimum Tax (AMT). Every year or so, Congress extends a “patch” designed to minimize the number of taxpayers paying the AMT. Each year, that patch becomes more expensive. Dr. Brannon cited a growing recognition that this strategy is not sustainable. The second reason is the expiration of the 2001 and 2003 tax cuts. The Economic Growth and Tax Relief Reconciliation Act of 2001 lowered the marginal tax rates on ordinary income and created a schedule for the elimination of the estate tax. The Jobs and Growth Tax Relief Reconciliation Act of 2003 lowered the marginal tax rates on dividends and capital gains. Under current law, both acts will expire at the end of 2010. Effective January 1, 2011, all marginal tax rates (and the estate tax parameters) will revert to their pre-2001 levels. In response, Dr. Brannon suggested that lawmakers will be forced to act in some way. Finally, Dr. Brannon noted a growing perception among lawmakers that the United States faces a structural deficit, and steps may be needed to address it.
Dr. Brannon noted that, with regard to the current tax code, no one likes the status quo. He argued that the tax code is complex, which may contribute to the tax gap and to perceptions that the code is unfair. The Code may also be inefficient, offering a hodge-podge of incentives that promote behaviors that would be undertaken even in the absence of a tax incentive, at times overlap, and even work at cross-purposes. He believes, however, that while Republicans and Democrats share a disdain for the current tax code, they differ in their specific objections.
Democrats, Dr. Brannon argued, believe the tax code is tilted in favor of the rich, and steps should be taken to increase progressivity. Republicans, in contrast, believe the tax code stifles economic growth, particularly through excessive capital taxation. One way to make the tax code more progressive, Dr. Brannon suggested, is to change many of the deductions (which have a value proportionate to the taxpayer’s marginal tax rate) to credits (which are worth the same to all taxpayers). For example, a home mortgage interest deduction of $1000 is worth $250 to a taxpayer in the 25% tax bracket, but only $100 to a taxpayer in the 10% bracket. In contrast, a 15% credit for mortgage interest payments would be worth $150 to both taxpayers. Republicans might argue that such a change tilts the tax burden more towards the high end of the income distribution.
One way to make the tax code more pro-growth, Dr. Brannon suggested, is to reduce the tax rates on savings and capital, possibly by raising or removing the income limits on contributions to individual retirement accounts or by reducing the tax rate on capital gains and dividends. Democrats might argue that such a change unfairly favors the high end of the income distribution. Dr. Brannon believes that combining the two strategies may allow Republicans and Democrats to reach a compromise on tax reform.
Dr. Brannon noted that lowering taxes on capital might be regressive and stressed the importance of spreading wealth accumulation to all parts of the income distribution. Toward that end, there are those investigating methods to encourage banks to offer services to individuals not currently utilizing the banking system and creating “kids accounts” whereby individuals would be endowed with a financial asset at birth.
Dr. Brannon concluded his talk by noting that any tax reform will create winners and losers. To the extent tax reform does not seek to also raise revenue, fewer losers will be created and thus fewer opponents to reform. To the extent the recent revenue growth continues over the next few years, there will be less need to use tax reform as a revenue raising or budget balancing vehicle.