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Archive for July 23rd, 2011

With America’s collective attention justifiably focused on the Phillies’ quest to add a right-handed hitting outfielder and the outcome of Kim Kardashian’s lawsuit against her equally buxom doppelganger, few have noticed that the nation’s deficit currently stands at a robust $1.4 trillion.

Recently, the bipartisan Senate “Gang of Six” has proposed a plan that would slash the deficit while simultaneously reducing the collective tax bill of American taxpayers by $1.5 trillion, courtesy of an extensive overhaul of the Internal Revenue Code.

I’ll spare you much in the way of discussion regarding how these savings are determined, as they are computed off a baseline projection that assumes many of the current tax provisions — such as the reduced Bush-era tax rates and the AMT exemption — will disappear as currently planned at the end of 2012 and 2011, respectively. This is an important and unlikely assumption, as few believe these tax breaks would be abruptly removed from the tax landscape under any scenario.

Instead, let’s focus on what the proposal would actually mean to your tax bill. The “Gang of Six” plan would:

  • Simplify the tax code by reducing the number of tax expenditures and reducing individual tax rates, by establishing three tax brackets with rates of 8–12 percent, 14–22 percent, and 23–29 percent (the current maximum individual rate is 35%).
  • Permanently repeal the $1.7 trillion Alternative Minimum Tax.
  • Reform, not eliminate, tax expenditures for health, charitable giving, homeownership, and retirement, and retain support for low-income workers and families. It is believed the deduction for mortgage interest (currently applicable for the first $1.1 million of qualified debt), would be greatly reduced.
  • Retain the Earned Income Tax Credit and the Child Tax Credit, or provide at least the same level of support for qualified beneficiaries.
  • Establish a single corporate tax rate between 23 percent and 29 percent, raise at least as much revenue as the current corporate tax system, and move to a competitive territorial tax system.

Although unstated in the proposal, popular opinion is that the plan would also offer the following:

  • The current 15% tax rate applied to long term capital gains and qualified dividends would be removed, and the tax on these items would be the same as the tax rate applied to ordinary income.
  • The current exemption under S103 for state and municipal bond interest would be removed.
  • The deduction for state and local taxes and miscellaneous itemized deductions would be removed.
  • Accelerated depreciation and the S199 deduction would disappear.

As you can see, while the “Gang of Six” claims that these changes will reduce taxes, this is based off the highly unlikely assumption that our collective tax bill would have greatly increased without this proposal, as the Bush-era tax cuts and AMT patch would disappear. If you were to compare the proposal to a much more likely future baseline (extension of the Bush-era cuts, at least for those earning less than $250,000, and a continuation of the AMT patch), the changes proposed by the “Gang of Six” would likely increase taxes due to the removal of so many key deductions and credits.

Of course, the real winner should this proposal come to fruition is me, or if you’d prefer a less selfish perspective, tax advisors in general. Any overhaul of the tax code would add an element of job security for the number-crunching CPA crowd, as we’ll be charged with the unenviable task of understanding and implementing these dramatic changes to an already near-incomrehensible series of laws.

For more on the proposal, see here and here.

 

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