taxreform-4.pngSupport is growing in Washington DC and around the country for comprehensive tax reform, defined as legislation to eliminate or curtail certain tax breaks, deductions, exclusions and loopholes in return for cutting tax rates.

President Obama recently proposed a business tax overhaul that would scale back tax credits and deductions and cut the top corporate tax rate to 28%. Others are looking at reform of individual income tax rules.

But tax reform is like healthcare reform and balancing the budget: everyone is for it in theory. It’s the specifics they disagree on. The devil is in the details.

What details? First, what tax deductions to eliminate? The old saying that one person’s tax incentive is another person’s tax loophole is not far from the truth on Capitol Hill. Read more.

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Tax Reform: The Devil is in the Details

Tue Mar 6, 2012

taxreform-4.pngSupport is growing in Washington DC and around the country for comprehensive tax reform, defined as legislation to eliminate or curtail certain tax breaks, deductions, exclusions and loopholes in return for cutting tax rates.

President Obama recently proposed a business tax overhaul that would scale back tax credits and deductions and cut the top corporate tax rate to 28%. Others are looking at reform of individual income tax rules.

But tax reform is like healthcare reform and balancing the budget: everyone is for it in theory. It’s the specifics they disagree on. The devil is in the details.

What details? First, what tax deductions to eliminate? The old saying that one person’s tax incentive is another person’s tax loophole is not far from the truth on Capitol Hill.

For example, should Congress eliminate the #1 most expensive tax exclusion? The one that’s estimated to cost the U.S. Treasury over $600 billion in lost revenue over five years? That would be the tax exclusion for employer-provided health insurance coverage, which includes employer and employee tax-free premiums.

The 2010 healthcare reform law includes a provision that would impose a new 40% excise tax on high-value or “Cadillac” health plans starting in 2018. Intended to pay for premium subsidies, this new tax proved so controversial Congress delayed its effective date for eight years. Even now many believe the tax will be modified before it takes effect.

Another candidate for elimination or curtailment under tax reform would be the #2 most expensive tax deduction: favorable tax treatment of contributions to 401(k) plans, IRAs and employer-sponsored defined benefit plans. Also in the $600 billion cost range, these tax breaks are generally considered to encourage savings and thus strengthen retirement security. While it’s possible that comprehensive tax reform might try to tilt tax incentives more equitably across income classes, it’s doubtful there would be much support for eliminating favorable tax treatment altogether.

The 3rd most expensive tax deduction, one that’s on everyone’s list of tax reform targets, is the deduction of mortgage interest on owner occupied residences, totaling just under $500 billion over five years. But with housing still in the tank five years after the housing market collapse, a vast quantity of unsold homes overhanging the market and prices still falling in many parts of the country, curtailing the mortgage interest deduction seems a nonstarter.

Another tax reform possibility, costing Uncle Sam about $250 billion over five years, is the federal tax deduction for state and local government income, sales and personal property taxes. Also in the mix is the tax-free treatment of interest earned on state and local government bonds. But with government budgets still in shambles and cutbacks continuing in public employment as services are curtailed, it’s not likely that Washington would want to put even more pressure on local governments by eliminating these deductions. The devil is in the details.

Nevertheless, momentum seems to be building on Capitol Hill to go forward with a plan to scale back tax deductions and reduce income tax rates—especially in the name of tax fairness. Surveys reveal growing concern among Americans that the Internal Revenue Code has become an encyclopedia of tax gimmicks that allow the rich to avoid paying their fair share.

If income tax rates could be sharply reduced as part of a fairness-driven tax reform effort, it’s believed, the public would support curtailment of some favored tax deductions and incentives.

Assuming Congress can forge a consensus around the goal of tax code fairness, there is one final “detail” that needs to be addressed: will tax reform be revenue-neutral or revenue-enhancing? Put another way, is the purpose of tax reform to make the tax code fairer or is it to raise revenue in order to reduce federal budget deficits?

Surely the devil is in the details when it comes to tax reform. But the real legislative battle will be waged over whether the whole tax reform exercise is really about finding ways to raise taxes.

As a practical matter it’s probably not possible to achieve bipartisan agreement on a comprehensive plan to reduce federal budget deficits and America’s $16 trillion public debt without additional revenue being factored into the equation.

Members of Congress from both political parties, senators and representatives, are hard at work behind the scenes exploring ways to make the tax code fairer, cut income tax rates, encourage economic growth and perhaps raise additional revenue as part of an historic deficit reduction plan. Regardless of who is elected president it seems certain that tax reform will be a national priority in 2013.

Regardless of political preferences, Americans need to give lawmakers time and space to do their work, with all options on the table, including some longstanding tax breaks. The devil is in the details but tax code fairness is an objective everyone can support.