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Revenue Neutral Tax Reform

September 21, 2012  |  tax reform
Revenue Neutral Tax Reform
Deborah Kramer, CPA - Stephenson & Warner Inc.,

Income Tax Reform – creates a strong response in everyone doesn’t it?  There are currently several commercials airing by the presidential candidates that attack the other candidate’s plan.  What should American voters’ response be rather than, “It’s about time!”?  We need to ask, “How would that work?” 

I recently read an article regarding whether revenue neutral plans are feasible, and the reasons wherein.  The contributors to this article are “nationally recognized experts in tax, budget, and social policy who have served at the highest levels of government”.  This being said, I read the article, then reviewed the statistics to see if they made sense to me with my level of experience and whether they supported the conclusions drawn in the articles.  The answer to both questions was yes.

What is a revenue neutral plan?  It is one in which we will maintain current tax revenues, ensure a progressive tax system, and maintain/lower marginal tax rates.  This necessarily creates a situation where these goals are in competition with each other.

How would revenue neutral tax reform work?  First, for corporate tax rates to remain revenue neutral while the tax rate is reduced, the loss of income to the government through lower corporate tax rates would be offset by reductions in corporate tax preferences.  Revenue neutral, right?

In putting together the revenue neutral model for individuals, several assumptions were made.  These included that tax expenditures aimed at promoting savings and investment would not be reduced, tax expenditures would be reduced or eliminated starting with the top tax brackets and working downward, the 2001, 2003 and 2010 tax cuts would be permanently extended, and no spending cuts would be made.

The plan examined by the article proposed reductions in individual and estate tax rates of approximately 20%.  This would decrease federal tax revenues by about $360 billion.  In order to remain revenue neutral, tax preferences would have to be reduced, the same as for corporate taxes.

In order to offset this loss in revenues, tax expenditures, read deductions/credits, would have to be reduced by approximately 65%.  This would be unprecedented, and to accomplish this would require deep reductions in popular benefits, including mortgage interest deduction, exclusion of employer-provided health insurance from income, charitable contributions, the Earned Income Tax Credit and Child Tax Credit. 

OK, so now you are really shocked!  The bottom line is that the majority of tax expenditures are going to individuals in the middle and lower income tax brackets.  It is not possible to design a revenue neutral plan that does not reduce “average” tax burdens even when made as progressive as possible. 

And on that note, consider the difference of tax burdens in taxpayers with similar incomes.  For example, families with children currently receive 57% of the available tax expenditures, but only 23% of the revenue reductions (as calculated in the article).  What this means is that an across-the-board reduction in tax expenditures would increase taxes on families much more than on childless adults.

I am not posing an attack on revenue neutral tax reform, but wanted to highlight some surprising results as posed in the article I read.  That being said, I do not necessarily feel that raising taxes on higher income taxpayers is the complete answer either.  The fiscal crisis that is looming has been a long time coming.