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Annette Nellen
Pushing for Specifics on Tax Reform Proposals

What do flatter rates, optional flat tax, everyone paying something, Opportunity Zones, Buffett Rule and simplification mean?

November 10, 2011
by Annette Nellen, CPA, Esq.

With the 2012 presidential campaign underway, tax reform ideas and sound bites abound, but details are usually scarce. To help understand the proposals, this article suggests some questions to ask of those promoting alternatives or changes to our current federal tax system.

Proposals

There are numerous proposals for reforming the federal tax system. Some are ideas, others offer some specifics, but very few have legislative language. Without legislative language, it is impossible to get a true picture of what the reform entails. Even with legislative language, without vetting, it is not clear what pieces may be missing. This section lists and briefly summarizes some of the proposals. Undoubtedly, more will surface as the presidential race develops, congressional races heat up and voters ask about expiring tax cuts. A reference list at the end of this article provides links to the tax plans summarized below:

  • President Obama: Various proposals have been offered in President Obama's annual budget proposals (Green Book), PERAB Tax Task Force (President's Economic Recovery Advisory Board) and deficit reduction plan. Some of the reform proposals in President Obama's Plan for Economic Growth and Deficit Reduction, include allowing tax cuts to expire for single individuals with income above $200,000 ($250,000 if MFJ (married filing jointly), indexing AMT (alternate minimum tax) for inflation, capping the benefit of itemized deductions at 28 percent, taxing carried interests as ordinary income, repealing oil and gas preferences, repealing LIFO, limiting earnings stripping by expatriated entities, deferring the deduction of interest expense related to deferred income and reinstating Superfund taxes. In President Obama's 2011 State-of-the-Union address, he called for a reduction in the corporate tax rate in a revenue neutral manner.
  • Congresswoman Michele Bachmann: Bachmann's 11-point blueprint calls for a dividend repatriation holiday. The plan also calls for fewer tax brackets, repeal of taxes included in the 2010 health care legislation, fixing the AMT, repeal of estate taxes and a "simpler and fairer" corporate tax system. In interviews, she has called for the "Reagan tax plan" as well as a lower capital gains rate.
  • Herman Cain: Cain's "9-9-9" plan calls for replacing all current taxes other than excise taxes with three taxes:
    1. A 9 percent business tax imposed on gross income less purchases from U.S.-located businesses, including capital investments and net exports. Payroll of employees working in "Empowerment Zones" is deductible. There would be no tax on repatriated earnings.
    2. A 9 percent personal tax on gross income less charitable deductions. There would be no tax on capital gains. Individuals who live or work in "Empowerment Zones" receive additional deductions.
    3. A 9 percent national sales tax

  • Jon Huntsman: Huntsman's plan entails a reformed income tax with all deductions and credits eliminated. Rates would drop to eight percent, 14 percent and 23 percent. The AMT would be repealed. Capital gains and dividends would not be taxed. The top corporate rate would be 25 percent. A territorial system would be implemented with a repatriation holiday.
  • Governor Rick Perry: Perry's plan includes allowing individuals the option of computing taxes using a 20 percent flat rate with a standard exemption of $12,500 and deductions for mortgage interest, charitable contributions and state and local taxes for families earning less than $500,000. There would be no tax on Social Security benefits, qualified dividends or capital gains. The estate tax would be repealed. The corporate rate would be 20 percent and "loopholes" would be eliminated. The system would move to a territorial one with a transitional lower rate on repatriated earnings.
  • Mitt Romney: Romney would maintain the current lowered individual tax rates and continue to work towards a flatter income tax with fewer deductions as suggested by the
  • Bowles-Simpson Commission for individuals with income below $200,000, there would be no tax on capital gains, dividends and interest. He advocates creation of a "Middle-Class Tax Savings Plan" to improve retirement savings. The estate tax would be repealed. The corporate tax rate would be lowered to 25 percent and the system moved from a worldwide base to a territorial base.

Questions to Help Get at the Specifics

Listed below is a sampling of questions that should be asked to get a better understanding of the tax proposals. For each question, the answers should include the details to support the answer. Without these details, it is not possible to truly understand the proposal and its ramifications:

  • Nature of the tax: Is the tax a consumption tax or an income tax?
  • Base changes: If the proposal calls for the elimination of all deductions and credits, does this also include the standard deduction and personal and dependency deductions?  Will current exclusions (such as for fringe benefits and gifts) also be repealed or scaled back?
  • Payroll taxes: If Social Security, Medicare or unemployment taxes are lowered or repealed, how will these programs continue to be funded?
  • Estate tax: If the estate and gift tax system is repealed, will there continue to be a tax-free step-up of basis at date of death? What would be the basis of a gift in the hands of the recipient?
  • If the plan includes a sales tax or VAT (value added tax):
    • Is the stated rate applied on a tax-inclusive or tax-exclusive basis?  (If the tax is imposed on a tax-inclusive basis, the effective rate is higher than the stated rate.)
    • Does the base include all services and property (real, personal and intangible)? If not, what is exempt and why?
    • How is pyramiding avoided (where businesses pay the tax and then embed it in the prices they charge)?
    • Does the tax apply to governments and charitable organizations?
    • Is the tax border adjustable (applied to imports, but not exports)?
    • What mechanism is provided to address the regressivity of the tax?
    • What transition rules are provided to prevent taxpayers from making significant purchases before the effective date? How will the businesses required to collect this tax get ready and will sufficient time be allowed?
    • Will the system enable states to use the federal system in place of their existing sales tax?
  • Simplification: How is the compliance burden for the proposal measured? Has the plan been reviewed by experienced tax preparers? Will recordkeeping needed by businesses tie to existing financial records or will new ones be needed?
  • Transparency: Will individuals and businesses understand how their income and transactions will be taxed? How will taxes not directly imposed on them (such as the corporate tax, taxes paid by governments, etc.) affect them?
  • Equity:
    • Individuals: For each income quintile of individuals, how will their share of income used directly and indirectly for federal taxes change from the current percentages? What is the effect on low-income workers of repealing the Earned Income Tax Credit?
    • Businesses: What is the effective tax rate for different industries, for capital and labor? How do these rates compare to the existing tax structure? What is the compliance burden and effective tax rate for different entity forms and how does it compare with the current tax system?
  • Tax gap: What measures will be included in the proposal to ensure compliance? How does the tax gap for the proposal compare to the existing federal tax gap?
  • International competitiveness: How does the proposal compare to the system used in other OECD countries? Over 140 countries use a VAT, if a VAT is not proposed, why? What is the compliance burden for individuals and small businesses?
  • Innovation: Will the research tax deduction and credit be maintained? How might the proposal effect business decisions on where to engage in R&D?
  • Worker classification: Does the proposal reduce or exacerbate the issue of properly classifying workers (employees or contractors)?
  • Employee benefits: If deductions or exclusions for employee benefits are removed, is it likely that employers will maintain such plans? What transition rules exist to help employees maintain existing benefits? What costs might there be to governments if fewer workers have health and other benefits?
  • State and local governments: What is the likely increase in borrowing costs for state and local governments when all interest income is tax exempt? What are the possible effects to subnational governments of repeal of low-income housing credits and other provisions that indirectly benefit them? If the federal income tax is changed significantly, how likely is it that state governments will be able to conform? If they do not conform, are any touted benefits of the federal reform diminished?
  • Specifics: Has the legislative language necessary to enact the proposal been crafted? If yes, is it complete in terms of indicating what provisions would be repealed, modified or added, transition rules, accounting periods and methods, compliance framework (reporting forms, due dates and penalties) and effective dates?
  • Debt and deficit: How does the proposal affect the deficit and debt?

Looking Forward

No doubt, there are a lot of questions that should be answered in order for anyone to truly understand the nature of and the effects of any of the numerous proposals currently being offered by possible presidential candidates. The sooner we can get answers to these questions, the more productive will be the debate on the proposals.

References

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Annette Nellen, CPA, Esq., is a tax professor and director of the MST Program at San José State University. Nellen is an active member of the tax sections of the AICPA, ABA and California State Bar. She chairs the AICPA’s Individual Income Taxation Technical Resource Panel. She has several reports on tax reform and a blog.