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Thursday, March 15, 2012

A Broken Record: Recent and Contemporary Arguments Concerning Tax Reform

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 Much of the debate in presidential primaries has centered on the perceived need for tax reform. Such reform would require substantial changes to the current version of the Internal Revenue Code, which, when enacted in 1986, was considered to represent “one of the most comprehensive revisions of the Federal income tax system since its inception.” Even in the 1980s, Congress was concerned that many taxpayers “found the prior-law tax system unfair and overly complex.” Further, Congress believed that a number of features of the prior-law tax system resulted in “excessive interference in labor, investment, and consumption decisions of taxpayers.” Staff of the Joint Committee on Taxation, General Explanation for the Tax Reform Act of 1986, at p. 6 (5/4/87) (“JCS-10-87”). Today, many of the same concerns can be heard on the Republican primary campaign trail. Indeed, it is not difficult to find political candidates and commentators faulting the Code in its approach to the legal tension between incentivizing certain behavior and avoiding excessive interference in labor, investment, and consumption. It seems the arguments have changed very little, as noted by the ABA Tax Section. Gail L. Richmond, “Tax Bites Revisits the 1986 Act Era,” 31 Sec. Tax’n News Q., no. 1, 2012 at p. 25.

By way of background, in enacting the 1986 Code, a primary objective of Congress was to provide a tax system that ensured individuals with similar incomes pay similar amounts of tax. With the adoption of certain restrictions, for example, on the use of passive losses to offset unrelated income, and other “base-broadening provisions,” Congress believed that it was no longer necessary to provide a lower tax rate for capital gain income of individuals, which would eliminate the incentive to re-characterize certain income in order to qualify for capital gains treatment. For individuals, the 1986 Code was designed to simplify the rate structure, establishing a 15% and 28% bracket. See JCS-10-87, at pp. 6-9.

Rick Santorum’s plan would reduce the number of tax rates to just two—10% and 28% (and would eliminate the corporate tax on manufacturers altogether). In evaluating that plan, recall the 1986 concern of Rep. Mel Levine that the legislation would harm the progressivity of the Code: “[T]he simple fact is, this bill leaves us with only two rates: 15 and 28 percent. It leaves a taxpayer with an income of $50,000 paying the same percentage on his income as someone making $500,000. No matter how unprogressive the current system may be, taxing individuals at such disparate levels of income at the same rate is just plain unfair.” 132 Cong. Rec. E3315-01 (1986). Whether there is anything unfair about that approach is an individual judgment. However, as a historical matter, it is not a novel idea. Also note that Santorum would triple the exemption for each child. That idea may be modeled after the changes introduced by the 1986 Code, which provided tax relief to low- and middle-income taxpayers by almost doubling the personal exemption. JCS-10-87, at p. 8.

Similarly, Mitt Romney would repeal the individual and corporate alternative minimum tax. See, by way of response, the 1985 statement of Sen. Robert Packwood: “If the public does not perceive the Tax Code as fair, then that does not bode well for this country or for this Congress. Consequently, we will enact a minimum tax taxing corporations, taxing wealthy individuals, and somehow requiring that they must pay some tax, no matter how legitimate their deductions … So there is a down side. But I think on balance it is more important that they pay some tax no matter how honest, legitimate, decent their deductions may be than they pay no tax and the public thinks that the Tax Code is unfair or immoral or unethical.” 131 Cong. Rec. S12873-01 (1985). Again, whether a particular scheme of taxation is “fair” or not is an individual judgment; but if the objective is a system which reduces the perception that tax avoidance schemes allow some to (perhaps unfairly) minimize their income tax liability, the alternative minimum tax was at one time viewed as a step in that direction.

Newt Gingrich, as well as Romney, has proposed to eliminate taxation of capital gains, which would re-introduce the incentive to re-characterize certain income in order to qualify for capital gains treatment. Interestingly, the repeal General Utilities doctrine, which had allowed capital gains from corporate liquidations to escape tax at the corporate level under prior law, was discussed in the context of changes favoring of efficiency. The Joint Committee on Taxation explained that the General Utilities doctrine “created a bias favoring acquisitions as a technique for tax-free realization of corporate gains and at the same time allowing the purchaser of the liquidating corporation’s assets a higher basis for purposes of depreciation and depletion.” JCS-10-87, at p. 10. To date, it appears that Gingrich has no stated position on the depreciation issue (except to the extent he supports allowing 100% “expensing” of equipment purchased) or how to reconcile it with tax-free treatment of capital gains, the repeal of the General Utilities doctrine, and his support for elimination of the estate tax. To his credit however, Gingrich’s suggestion of an alternative system of taxing income less a standard deduction and deductions for charitable contributions and for home ownership would seem to simplify the Code for many taxpayers (although it would add another layer of complexity to the extent it would require an analysis of whether to take advantage of that option).

These are just a few of the candidates’ ideas available on their respective campaign websites and summarized on the Bloomberg BNA Presidential Candidates’ Tax Plan Comparison. For those interested in the issue, it may be worth the time to further evaluate the candidates’ positions on income taxes in light of the principles and policies of the 1986 Code, the current Code, which are nicely summarized by the Joint Committee of Taxation in JCS-10-87. Whatever one’s views on the fairness and efficiency of the current Code, its history is one that we all share. As for what the Code should be, it seems that many of the candidates’ ideas are strikingly similar to the arguments presented in the time leading up to the enactment of the Code we have now or can be viewed as a return to prior law, which was criticized for its “excessive interference in labor, investment, and consumption decisions of taxpayers.” JCS-10-87, p. 6.

-Ryan Prillaman
Business Entities Group
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