Len Burman, an Urban Institute senior fellow and co-director of the Urban-Brookings Tax Policy Center, works to demystify the tax system and illustrate how taxpayers will feel changes—including those that the President's Advisory Panel on Federal Tax Reform are now recommending.
Five Questions Archives
1. What would an ideal tax reform accomplish?
An ideal tax reform would make the tax system simpler, fairer, and more efficient. Doing that is a lot harder than it sounds. The goals often conflict. For example, progressivity means the tax rates increase with income. But going that route entails an efficiency cost since the economy grows faster when people are paying less tax.
Still, there are some obvious ways to make the tax system simpler and more efficient without sacrificing fairness. We could eliminate the tax expenditures that aren't worth the lost tax revenues and complexity. And we could consolidate the ones we want to keep so there's not a whole long laundry list of, say, education tax incentives.
We also could eliminate the individual alternative minimum tax (AMT), which scores the trifecta of bad tax policy. It's inefficient and a lot of people face higher tax rates under the AMT than they would under the regular tax system. It's unfair because people in very similar situations can face very different taxes because of the AMT. And, it's mind-bogglingly complex.
Done right, reform could strengthen our tax base without revenue losses, which is important with today's gargantuan deficits. And all of these changes will make the tax system much simpler and more transparent, and arguably fairer as well.
With the junk cleaned out of the tax system, most people would face lower rates than they do now. They would have more incentive to work and save, and less incentive to invest in unproductive tax shelters.
2. Who are the winners and losers of recent federal tax changes?
We don't know. The changes over the last four years have been tax cuts and we haven't paid for those cuts, either by reducing spending or by increasing other taxes. We paid for them by increasing the deficit. What that means is that someone else is going to have to pay for those tax cuts. And we don't know who.
It could be our children who pay, or it could be us a few years from now. Will we pay for those cuts by slashing food stamps and Medicare and Medicaid? In that case, low- and middle-income Americans could be worse off. Alternatively, if we raise tax rates on rich people, then they could end up worse off than they would have been without the tax cuts.
At first glance, it looks like most people got tax cuts over the last four years. But the biggest tax cuts by far went to very wealthy people. The average tax cut for people making more than a million dollars in 2005 was over $103,000. People earning less than $10,000 got $4. The average cut was $1,400. So people at the top got a tax cut that was 70 times as big as the average.
With everyone getting some tax cut, the politicians have accomplished a great trick. They've made everybody believe they're better off. But the tax cuts still have to be paid for. Eventually, politicians will have to decide the winners and losers.
3. Is the growing number of social programs injected into the tax code a good thing?
No, a cost is a cost, so let's be honest about it. We pretend that if the government provides education through the tax system, then that's a tax cut, not a spending program. But if the government puts more money into vouchers or Pell Grants that help low-income people go to college, that's government growth and we're spending more money. By this logic, Pell Grants are bad, whereas the tax credits are good. It's simply not true.
Some things make sense to do through the tax system. For instance, having a subsidy [EITC] for low-income people who work. But the huge panoply of social programs injected into the tax code complicates it horribly, and not all these programs help the people they're supposed to help.
Let's go back to education subsidies. The 35 to 40 percent of households that don't pay any income taxes don't get any benefit from nonrefundable tax credits and deductions, which is what these education tax subsidies are. So it's not helping low-income people get to college. It's helping middle-income people. It's not the most efficient way to do it. And it makes people think the tax system is unfair.
Taxes have to be higher to pay for all these tax breaks. So you can imagine two different systems. One without most unwarranted tax subsidies and lower rates across the board. And another that taxes people more, but—if they are well advised, tenacious, and do the things government tells them to do—gives them the money back.
From my perspective, it's best to have the tax system just collect less tax to begin with, without making people jump through so many hoops to get their money back. What I'd like policymakers to address honestly is whether some tax subsidies would be better run as regular government programs.
If we can't accomplish social goals through direct spending programs, it might be better to use the tax system than not to do it at all. Lots of Americans are struggling and some tax expenditure programs do help people near the edge.
4. Why not replace the income tax with a national sales tax?
There are two reasons. One because it would be patently unfair and, two, because it wouldn't work.
The idea of a national retail sales tax is to replace the income tax with something like what the states use—a sales tax on all purchases. So if the tax rate were 25 percent, the price of a $1 product would be $1.25. The government would get the 25 cents. It sounds really simple and people don't object too much to state sales taxes. They think they're easier to comply with than the income tax.
The problem? High rates that would be required under a national sales tax. My TPC colleague Bill Gale looked at what the rates would be under a very broad-based sales tax applied nationally to replace all of the other federal taxes—and the rate would have to be 44 percent. And even that high rate wouldn't raise enough revenue because it doesn't take tax evasion into account and it assumes everything, even food, housing, and life-saving medicine, would be in the base—which would be politically difficult to do.
At a 44-percent tax rate, lots of people would start moving transactions underground. If that happened, you would need a rate much higher than 44 percent to raise enough revenue to pay for a government at its current size. Second, it would eviscerate state tax bases because when people start evading the federal taxes, they're also going to evade state taxes. States would have to raise their tax rates.
Another problem is that people are not going to want to calculate state income tax once the federal tax has been voided. So states would have to rely entirely on sales taxes. And that's problematic. State sales tax bases are already losing out on Internet commerce. States might have to substantially cut services.
Some people say that the flat tax is the fairest tax. I disagree. The current tax system is based on the notion of ability to pay. High-income people have a much greater ability to pay taxes than low-income people do.
Under the national retail sales tax proposal, families would get a grant to offset the tax owed on some minimal level of consumption. But it wouldn't include an earned income tax credit to low-income working people. And millionaires would be paying taxes at the same rate as someone earning $40,000 a year. That certainly violates most people's notion of fairness.
5. How does the Tax Policy Center monitor these trends?
The Tax Policy Center views its role as educating the public about tax policy. We think that a lot of bad policy gets made because taxes are so complex. People don't understand what politicians are doing and aren't as engaged in the political process as they might.
TPC writes policy briefs and longer discussion papers that explain the consequences of different policy choices. We also testify before Congress a fair amount. We do speeches, and Op-Eds, and commentary. We spend a lot of time talking to reporters and staffs of congressional offices, just explaining to them how these things work.
My colleagues and I have written extensively about the individual alternative minimum tax (AMT), an issue pretty much below the public's radar screen three or four years ago. Now that it's become prominent, the tax reform panel [President's Advisory Panel on Federal Tax Reform established in January 2005] has promised to eliminate the AMT as part of any tax reform proposal.
We keep an eye on the short term and long term. We comment on current issues that are in public play. We also have a longer-term research agenda to try to anticipate tomorrow's policy issues and shed light on effective policy options. Politicians have hidden behind a curtain of complexity in the tax system. We're trying to remove the veil and explain how the tax system affects people.
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