income tax reform

It's exciting to see President Obama propose the elimination of some loopholes. But it's frustrating that he won't propose getting rid of all of them, even all of those that disproportionately benefit the wealthy-- e.g., the HMID.

It's exciting to see people defend flat taxes-- e.g., the federal payroll tax on income and a variety of state income taxes such as Massachusetts. But it's frustrating to see people demagogue a flat "income tax" on income at the federal level or push so hard for multiple tax brackets. (In the WSJ recently, John Gordon provides a history of the income tax.)

Loopholes are tough, politically-- as is common, since the benefits go to a powerful special interest group while the costs are relatively subtle. The results are never efficient and rarely equitable. Politicians don't respond out of ignorance, because they're in the pocket of interest groups, don't want to reduce loopholes without reducing rates, etc. And the general public (as usual) pays little attention to arcane policy details. You'd hope that advocates for the poor would step up, but that's rare indeed.

One promising angle: eliminating loopholes to attack the deficit. For example, eliminating the HMID and the subsidy on health insurance through employers would raise more than $2 trillion over a decade.

A "flat tax" with exempted income results in a progressive tax structure. If $30K is exempted, then an income of $40K has only $10K of taxable income. Assuming a 20% tax rate, they would pay $2K or 5% of their income as an average tax rate. An income of $120K would have $90K exposed to taxation, resulting in $18K in taxes for a 6.7% average tax rate. And so on.

This also helps explain how the Bush tax cuts could have increased the progressivity of the federal income tax code. By reducing rates on the lower end, even a tax cut for the wealthy could increase progressivity on net. There's a lot of confusion about the "Bush tax cuts"-- even focusing on the non-Keynesian reduction in marginal tax rates. People often think the cuts only went to the wealthy-- and that's not (close to) the case. 

In the WSJ, Stephen Moore runs with the ball:

"Suddenly, liberal Democrats are making the same argument about the tax code that I've been making for 20 years," laughs former Republican House Majority Leader Dick Armey. "Welcome to the party." Mr. Armey, who along with Steve Forbes has been the torch bearer for the flat tax since the early 1990s, believes that the latest applause line from President Obama that "billionaires should pay the same tax rate as janitors" may be the political gateway to sweeping tax reform...inadvertently helped as Mr. Obama and his new best friend, billionaire Warren Buffett, barnstorm the country trashing the tax system for, as the Oracle of Omaha puts it, "coddling the super rich." In truth, the system isn't nearly as skewed in favor of those at the top of the income pyramid as they allege: Today the top 1% pay 38% of the income tax. But in Washington, perception drives policy. The virtue of a flat tax with no deductions is that it provides an ironclad guarantee that the rich pay no lower a tax rate than janitors and secretaries.

This past summer the Senate Budget Committee, which is run by Democrats, reported that 26.5% of all tax deductions and credits are taken by those with incomes in the top 1% on the wealth scale...

Democrat Kent Conrad of North Dakota, the chairman of the Senate Budget Committee, says that loopholes are "subsidies, and subsidies are not the type of thing that you want for an efficient market system." He sounds like Milton Friedman there and he proposes to reduce "tax expenditures" by 17%. Why stop there? Republicans should counter-offer: We see your 17% and raise it to 100%...

The candidate who comes closest to a true flat tax is Herman Cain, the former Godfather's Pizza CEO. His argument for a "9-9-9" plan puts the current income and payroll taxes in the shredder and replaces them with a 9% personal income tax with no deductions, a 9% net business income tax, and a 9% national sales tax...