# Presentation: 138325

## Tax Reform and Fairness for FamiliesPresentation to the President’s Advisory Panel on Federal Tax Reform New Orleans, LAMarch 23, 2005

- Eugene Steuerle
***Co-Director, Urban-Brookings Tax Policy Center***
- &
***Former Economic Coordinator,***
***Treasury 1984-6 Project for Tax Reform***

## Outline

- Tax system affects almost every area of family’s life
- Many tax subsidies are complex, unfair, inefficient, non-transparent, and corrupting
- IRS does *NOT* monitor subsidies’ effectiveness
- Much spending is hidden in taxation
- Much taxation is hidden in spending
- Tax reform cannot avoid addressing these “policies”
- True tax reform identifies who is going to pay

## Pervasiveness of Tax Subsidies

- Child-related subsidies (EITC larger than welfare)
- Housing tax subsidies(larger than HUD budget)
- Charitable incentives
- Subsidies for states/localities
- Health tax subsidies (for workers, larger than any direct spending program)
- Retirement/saving incentives (revenue loss greater than total personal saving)
- Higher education incentives
- Business subsidies (that differentiate among families by source of income, not ability to pay)

## Slide 4

## Many Subsidies Poorly Designed As Tax or Spending Programs

- Complex
- Provide unequal justice to taxpayers with equal ability to pay (horizontal inequity)
- Regressive (vertical inequity)
- Poorly targeted to need
- Non-transparent
- Corrupting

## Child Provisions & Phase Outs

- Earned Income Tax Credit
- Refundable Child Credit
- Dependent Exemption
- EITC phase out
- Child credit phase out
- Dependent exemption phase out
- Dependent exemption as AMT tax shelter
- Head of household status
***Some opportunities***: one unified credit; integrate phase outs or fold into rate schedule

## Slide 7

## Housing Subsidies: Mainly Through Tax Code 

- For poor, rental but no ownership subsidies (e.g., low income housing tax credit)
- For moderate income, no rental or tax subsidies, only higher prices
- For middle class, some tax breaks
- For higher-income, the largest subsidies
- Interest deduction rules confusing & prone to error (e.g., secondary versus primary mortgages)
***Some opportunities***: simplify & level out the subsidies

## Slide 9

## Charitable Incentives

- Subsidies could be better designed to promote giving
- Cash and in-kind contributions sources of cheating & invite corruption
- Little IRS enforcement for charitable organizations
- For some contributions, government subsidy goes mainly to intermediaries, not to charity
***Some opportunities***: fold together bills for improving incentives & removing abuses (Senator Grassley statement & my Senate Finance testimony)

## State & Local

- State & local tax deduction
- Capped already because of AMT
- Proposed for elimination in 1984 Treasury study
- Public purpose tax-exempt bonds
- Private purpose tax-exempt bonds
- Often promote arbitrage, not net new investment
- Favor lobbyists with political connections
- Newer credit based bonds (e.g. for local school construction)
- Empowerment/enterprise zones
- Favor those on “right” side of the street
***Some opportunities***: AMT forces decision on S&L tax deductibility; limit or better target private bonds/zone subsidies to real needs

## Health Tax Subsidies

- Largest for the richest and those with highest cost plans
- Current subsidies of about $150 billion will rise by another $100 billion annually within a few years
- That increase of $100 billion will likely *INCREASE* number of uninsured
- By adding to cost pressures
***Some opportunities***: Spend additional subsidies more wisely & distribute to reduce number of uninsured

## Retirement Plan Subsidies

- Dozens of plan options
- Substantial complexity
- Much of return lost to intermediaries
- Tax subsidies for retirement now in excess of total personal saving!
- Existing subsidies not for saving, but  deposits
***Some opportunities***: Simplify, level out subsidies

## Retirement Plan Options Under Current Law

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- <date/time>

**Retirement Plan Options Under Current Law**

## Higher Education Subsidies

- Many and contradictory
- Distributed somewhat randomly
- Complex and not well integrated with direct aid
- Often high marginal tax rates
***Some opportunities***: Unify into one tax program; fold into Pell grants

## Slide 16

## Some Business Tax Incentives 

- Special subsidies by type of business (e.g., small business, energy)
- Affect families very differently
- Not based on ability to pay
- Often favor rich owner of subsidized business over poor owner of unsubsidized business
***Some opportunities***: Target benefits better; if consumption tax treatment sought, treat interest deductions consistently

## Trade-offs still required

- EXAMPLES
- Simplicity may dictate rough justice
- Simple subsidies may be very inefficient
- Progressivity often leads to high tax rates and marriage penalties on moderate income taxpayers

## Weak Enforcement & Monitoring

- Great difficulty administering
- Noncompliance highest when no reports (1099s)
- Very few taxpayers audited
- Almost no monitoring for effectiveness for almost all subsidies
- Treasury & IRS proclaim inability:
- Don’t have data (“data constraints may limit assessment of effectiveness”—U.S. Treasury)
- Can’t currently fulfill Government Performance & Results Act of 1983 (GPRA) requirement to develop strategic plans for programs

## Why Spending is Hidden in Taxation 

- Tax subsidies in budget show up as:
- Reduced taxation
- No increase in spending
- In reality
- Same economic effects as spending
- Cause higher tax rates
- Perhaps 1/4 to 1/3 of all government spending is in tax system
- Social spending now larger fraction of pie

## Slide 21

## Many Taxes Hidden

- Derives mainly from:
- (1) Phase outs in tax programs
- (2) Phase outs in spending programs
- Net result for moderate income families:
- Very high marginal tax rates
- Huge marriage penalties
- Implications:
- Concern over high tax rates must take into account other government programs
- Removal of income tax still leaves many families subject to income accounting

## Slide 23

## Is There a Magic Bullet?

- Current system really like three:
- Poor – child credits, EITC expenditures
- Middle class – incentives, deductions galore
- Rich - zero taxes on many accruals
-             - double taxes on some income
- Solving for one group doesn’t solve for others
- Endless search for magic bullet
- Flat tax, consumption tax
- Still must decide charitable, housing & other policy

## Conclusion

- Tax reform is possible
- We’ve done it before
- Budget necessity and public outrage over complexity of AMT could force issue
- But it’s very hard work
- Tax reform is a test case for systemic reform requirements of a new fiscal era
- Recognizing who pays
- Requiring proof of performance to continue programs