Much of the current debate about the fiscal cliff has focused on the marginal tax rates for the highest income earners.
President Obama wants the top two rates to rise, with the 33 percent rate going up to 36 percent and the 35 percent rate rising to 39.6 percent. Most Republicans want to keep all marginal rates where they are now and find revenue by curtailing exemptions, credits and deductions in the tax code.
The politics of it all is the kind of high drama that drives Washington, and almost lost in the discussion is the only substantive proposal in recent years to return fiscal order to the federal government: the Simpson-Bowles Commission report.
That bi-partisan report addressed the tax issue, beginning with the assessment that our method of collecting the revenue necessary to sustain government services is broken.
“In the quarter century since the last comprehensive tax reform, Washington has riddled the system with countless tax expenditures, which are simply spending by another name,” the report says.
And that spending is considerable. According to the Simpson-Bowles report, these earmarks amount to $1.1 trillion a year. That’s roughly the size of our annual deficits.
We’re not talking exclusively about loopholes, which are used as an exploitation of the code as a way of avoiding taxes. No, this is about volumes of deductions, credits and exemptions that favor certain kinds of behavior.
Of course, nobody wants to give up their particular tax benefit. Think of the protests if Congress tried to eliminate the deduction for home mortgages or the child tax credit. The Simpson-Bowles Commission, however, suggested doing just that as one of its tax reform options.
“The Commission proposed tax reform that relies on ‘zero-based-budgeting’ by eliminating all income tax expenditures… and then using the revenue to lower rates and reduce the deficits.”
In short, skip all the cumbersome and confusing tax preparation paperwork and lose the deductions and credits, but pay a lower tax rate. The Commission says we could have just three tax rates if all tax expenditures were eliminated—8 percent, 14 percent and 23 percent, with a corporate rate of 26 percent.
Or you could keep certain popular deductions, like the child tax credit, but pay slightly higher rates: 9 percent, 15 percent and 24 percent, with a corporate rate of 26 percent.
The Commission’s suggestions return to the fundamental objective of the tax code—the fair and equitable collection of revenue to operate government. In doing so, the Commission sweeps clean the tax code that lobbyists and politicians have manipulated for generations, all the while further empowering themselves and their clients.
The average American, unable to afford a lobbyist or a team of tax lawyers, is left with the ignominious task of trying to calculate (or miscalculate) how much of his earnings must be turned in to local, state and federal governments.
I suspect the President and the Congress will eventually strike some deal that will avoid the fiscal cliff, but only touch the margins of the real problem and conveniently ignore the tough, but fair recommendations in Simpson-Bowles.