DATELINE: November 10, 2010, Chicago
Today the Co-Chairs of the President Obama’s Deficit Commission issued a 50-page draft proposal for addressing the fiscal problems facing the United States. One can make the case that the proposal is dead on arrival. It gores way too many oxen, but tabling this proposal would be unfortunate. The U.S. faces serious budgetary issues, and this proposal is a good faith attempt to address them by spreading the pain around.
Co-chairs Allan Simpson and Erskine Bowels ask virtually everyone to...
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go on a diet. With divided government returning to the U.S. in January 2011, we would hope that this refreshing exercise in candor would cause both sides of the aisle to think about what is best for the country rather than what posturing best preserves their jobs. We can only hope.
The problem with the proposal is that everyone has skin in the game that they will want to protect. Take the charitable sector. As we read the proposal, the deduction for charitable contributions would be eliminated--the proposal says it eliminates all tax expenditures, which we assume include the deduction for charitable contributions.
We imagine that there are already heated calls to lobbyists to stop that from happening. What we are about to say is blasphemy: Eliminating the deduction for charitable contributions is a small price to pay for fiscal integrity and tax simplification. Eliminating all tax expenditures, as is proposed, would greatly simplify the tax system, saving billions of dollars in compliance costs. It would also eliminate distortions created by tax expenditures. For example, a state government’s decision as to whether to finance government through an income tax, sales tax, or property tax would be a tax neutral one at the federal level. The proposal would also result in lower individual and corporate income tax rates.
Its time to shake things up for the better.
Unfortunately, charities will view this quite differently. The deduction for charitable contribution serves two purposes. First, it is a form of subsidy. But we suspect that it is the other purpose that appeals to the charities more. It is a marketing gimmick. “Give to us because it reduces your taxes.” As long as the tax subsidy takes the form of a deduction, people would be better off not giving to a charity if their goal is to net more cash. As it stands now, they can reduce the cost, but there is still a cost. One can make the case that eliminating the subsidy would make contributors better consumers of the implicit goods and services they are buying when they make a contribution. Getting rid of the charitable contribution deduction would also effectively put an end to planned giving devices—assuming the elimination of these subsidies also was reflected in the currently nonexistent estate tax. Donors should ask: Why is a charity asking me to buy an annuity, income stream, or and investment product? Aren't they in the business of providing culture, social services, and education? The fact that charitable gift annuities, remainder trusts, lead trusts, and pooled income funds exist tells you exactly how much complexity the tax system spawns.
Simpson and Bowles have been quite clever in how they structured the proposal. They didn’t just propose eliminating all tax expenditures. They said, “These are the rates if you do, but if you must have a tax expenditure, than we will increase the rates to reflect the cost of the expenditures that are chosen." In effect, they are forcing everyone to look at the cost of tax expenditures.
We referenced the current sorry state of our politics. Already shoving us further into the pit is presumptive House Oversight Committee Chairman Darrell Issa, who has irresponsibly promised endless investigations. Even today’s Wall Street Journal thinks his strategy is too extreme. Rather than sticking their axes in each other, we think Democrats and Republicans should devote their energies to enacting a form of this proposal. The Democrats won’t like the cut in corporate taxes, even though formal Ways & Means Committee Chairman Rangel supported lower rates before stepping down. Nor will they like the elimination of the earned income tax credit, the alternative minimum tax, or the elimination of the education tax credits that were enacted during the Clinton Administration. The education tax credits haven’t saved one family a nickel (maybe a nickel, but any savings are largely an illusion) in tuition costs—at least that is what we suspect economists would tell us. Instead, they have only served to subsidize tuition increases that seem to always exceed the cost of inflation.
But the Democrats aren’t the only ones who have something to cry about. Can you imagine how the Republicans will react to taxing capital gains and dividends at the same rate as earned income? Moreover, a chart accompanying the report indicates that it is the wealthy who derive the most benefit from tax expenditures. However, it is the wealthy who have the highest compliance costs.
Given the potential pain felt by both sides of the political spectrum, we see fertile ground for compromise. Kudos to Allen Simpson and Erskine Bowles. The question is whether charities and other special interests will choose to perpetuate the status quo, or consider the potential overall benefits to the proposal.
One thing is for sure, Simpson and Bowles offer a refreshing breath of fresh air following the juvenile nature of the just completed political campaign season. Too bad they didn't run for office.
Internal Revenue Service - Circular 230 Disclosure: As provided for in Treasury regulations, any advice (but none is intended) relating to federal taxes that is contained in this communication is not intended or written to be used, and cannot be used, for the purpose of (1) avoiding penalties under the Internal Revenue Code or (2) promoting, marketing or recommending to another party any plan or arrangement addressed herein.
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