Tax Reform

We hear lots of talk about tax reform and lots about health care reform, but rarely hear about the two together. While there are proposals to change the exclusion for employer-provided health care, such as President Bush's proposal to remove it and provide a standard deduction for health insurance, they typically don't consider either the entire health care or tax reform picture.

There are significant dollars in the tax code that should be on the table in reforming health care. All of the government dollars should be in the picture in looking at how to fund any change, such as universal coverage. The largest federal tax expenditure is the one where employees are not required to include in taxable income the value of the health insurance their employer provides to them. The estimated cost of this expenditure in 2007 was $134 billion.  There are other health care tax breaks as well such as the itemized deduction for medical care and health savings accounts.

Last week, the Center for Disease Control and Prevention (CDC) reported that life expectancy has gone up, hitting a "record high in 2006 of 78.1 years."

This kind of trend data is relevant to tax reform discussions, but not often highlighted. Tax reform discussions could be better focused if we spent more time looking at how the world has changed since most of our current rules were enacted and how it will likely continue to change.

Several years ago I started gathering data on trends and using it to show where our tax law was outdated or working contrary to a trend, that is - contrary to reality. A few simple examples:

1. Longevity - this is clearly relevant in considering our Social Security system. When Social Security was created in the 1930s, life expectancy was lower than retirement age. That is clearly not the case today.

2. Who lives in poverty - In 1959, 35.2% of people age 65 and older were in poverty. In 1996, that percentage had dropped to 10.8%. (Leatha Lamison-White, Poverty in the United States: 1996, U.S. Department of Commerce, Bureau of the Census, Table C-2, page C-5). The federal tax law (as well as some state income tax laws) include exemptions and credits for being old. Years ago it may have been appropriate to assume that most elderly needed a tax break, but that is not true today.

Senate debate this week on addressing climate change is raising concerns about further raising the cost of gasoline (see NY Times article and Senate Environment and Public Works Committee website for debate info).  While higher prices are hard to sell to the public, it sounds like we're missing the point.  If we want to address climate change, we need to reduce greenhouse gas emissions. The most significant greenhouse gas is carbon (CO2) from burning fossil fuels such as oil. Economics would say to reduce demand of something, raise its price.

At least once every decade since at least the 1960s, there has been talk of serious tax reform in Congress.  I came across a 1998 quote from then chair of the Senate Finance Committee, Senator Roth announcing his desire to review the international tax provisions in light of the current state of global markets. He stated: "We need to fundamentally rethink the tax code with a view to enhancing American competitiveness in the new global economy and helping the American workforce. In order to ensure that we enact policies that will lead the United States into the 21st Century at the forefront of competition, as Chairman of the Finance Committee, I intend to hold hearings over the coming year to explore the ramifications of the changing world economy and the needed reforms in both the international tax and trade areas. The cornerstones of these hearings will be ensuring economic growth in our domestic economy and competitiveness overseas. We must determine how our existing international tax regime, which was designed to address the needs of a totally different age, can be reengineered to complement the changing international marketplace and changing business profiles. We must also strive to encourage the creation of more jobs that draw on these new opportunities."  [Source: "U.S. Finance Committee Chair Roth's Address at Forum on Taxation of Multinationals," 98 TNI 192-24, October 1, 1998.]

While well-intentioned and needed, a recent bill passed by a tax-writing committee also indicates the need for a serious look at our federal income tax system to see how it can be simplified, made more logical in terms of what we want it to do in addition to raising revenue, and how it can support economic growth.  This bill makes it even more obvious that our federal income tax is in need of some type of reform.

On May 15, 2008, the House Ways & Means Committee passed HR 6049 which makes many changes to our federal income tax.  Many of these changes are 1 year extenders of provisions that expired at 12/31/07, such as the itemized alternative deduction for sales tax, the deduction for qualified tuition and expenses, and some energy incentives.  In total, 33 expired provisions were extended for one more year!  That avoids the issue of having to determine if they should be made permanent or if they have served their purpose and are no longer needed.  These temporary provisions make tax planning difficult (for example, will the benefit be renewed or should alternatives be pursued by taxpayers).

Ordinary Americans may not realize how closely linked their health care is to the U.S. tax code, but a bevy of analysts and economists could give them an earful. The major health reform plans on the table involve changes—in some cases pretty significant changes to tax treatment of health insurance, particularly the tax breaks for insurance we get through our jobs. Over at the Taxvox blog, sponsored by a joint program of the Urban Institute and the Brookings Institution, Howard Gleckman explains some of the options in a post nicely titled, "Forget Death and Taxes, How About Health and Taxes?"

Gleckman focuses on proposals for a Value Added Tax or VAT, a model seen in several European countries. VAT scenarios are circulating more in the academic/think tank world right now than in the political discourse about health care, but as Gleckman points out:

"The expiration of the Bush tax cuts and the ongoing Alternative Minimum Tax mess will surely drive big tax changes in 2009 or 2010. Health reform is also on the table, although short-term odds for reform may be longer. The question is: How will these two mega-issues fit together?"

A few days ago, the GAO released a report - Value-Added Taxes: Lessons Learned from Other Countries on Compliance Risks, Administrative Costs, Compliance Burden, and Transition.

Why? Doesn't the GAO know that the US doesn't like the VAT?

In the report, the GAO notes that tax reform includes discussion of a VAT and that it was asked to do this report by Congressmen Jim McCrery and Jim Ramstad of the House Ways & Means Committee. The countries reviewed by the GAO in this report are Australia, Canada, France, New Zealand and the UK.

The tax code is a mess. Even those pointy-headed economists that can bicker about anything (except the gas tax) agree that it is too complicated. They cry in virtual unison that the growth of tax deductions, credits, and deferrals leads to inefficiencies and market distortions (yikes!).

To confirm these fears, we need look no further than the education arena. Do you know how many tax provisions there are designed to support post secondary education and workforce training? It's a long list.

There are tax breaks for contributions to specific accounts and savings plans such as Coverdell education savings accounts, section 529 college savings plans, pre-paid tuition plans, and penalty-free withdrawals from IRAs. Further, there are other tax breaks that cover the treatment of educational expenses. These include the Hope Credit, Lifetime Learning Credit, deduction for tuition and fees, and the deduction for interest on student loans. So, that's a count of at least 8.

Many of these overlap and as such they cause a great deal confusion among consumers. Last week the House Ways and Means Commitee held a hearing on this topic and I sent in some testimony that offered my take on the matter.

BASS EXPANDS ON TAX REVIEW: The incoming California Assembly Speaker Karen Bass explains her plans for a tax reform commission in an interview with the Associated Press. Aaron McLear, a spokesman for the governor, is quoted as saying that the governor is interested in tax reform but it's "not a substitute for reforming our broken budget system." Yes, and no. Clearly, the state budget process needs procedural changes, and there are strong arguments for establishing a real reserve and an ability to respond more effectively to changes in revenue. But the main failed attempts at spending-side budget reform suggests that budget reform may not be possible without tax reform.

On April 16, 2008, Maine enacted a law that doubles its beer and wine excise taxes and creates a new tax on soda syrup (LD 2247, Chapter 629). The syrup tax is $4/gallon and 42 cents/gallon of bottled soft drinks and those made from powder (see 4/17/08 article in the Portland Press Herald). The revenues will be used for the state's health insurance program called Dirigo. One estimate is that the syrup tax will mean about $28K of new taxes for an average McDonald's.

The new law defines soft drink broadly as "any nonalcoholic beverage, whether naturally or artificially flavored, whether carbonated or noncarbonated, sold for human consumption, including, but not limited to, soda water, cola and other flavored drinks, any fruit or vegetable drink containing 10% or less of natural fruit juice or natural vegetable juice and all other drinks and beverages commonly referred to as soft drinks, but not including coffee or tea unless the coffee or tea is bottled as a liquid for sale." Unflavored water and milk are exempted.