As Obama is inaugurated Tuesday and his economic team takes up residence, Americans must remain vigilant to press for desperately needed changes in economic and tax policies. Those put in place under Bush have failed miserably. We know now (if we didn't before) that deregulating financial institutions and credit rating agencies was a poor idea, since greed will almost always lead to behavior that carries systemic risk. We know now (if we didn't before) that instituting deep cuts in revenues to a government in the midst of conducting two extraordinarily costly wars (and in the face of evidence of gross corruption, cronyism and incompetence) is a sure-fire way to dig a deficit hole that will be hard to get out of, while creating a mountain of debt that will be more and more expensive to service. The debt burden is now above $10 trillion, and the deficit, for 2009 alone, is now projected by the CBO to be at least $1.2 trillion. None of this, my friends, is mere chicken feed.
So if we are to remain vigilant and to press the Obama team (especially those many leftovers from a Clinton administration that was itself too invested in neoliberal policies), what should we be pressing for? First, we should recognize that we cannot go on spending while cutting taxes. Our borrowing capacity is limited, and our repayment capacity is nonexistent until we face up to the need to increase taxes. Second, we should push for tax increases that will ultimately result in a stronger democracy with less inequality between the top and the bottom income groups.
Here, my friends, is my wish list for tax improvements.
A) Personal Tax Issues
1) Reform the AMT to create a modified gross income threshold for applicability, with the goal of exempting ordinary taxpayers making $50,000 annually or less (couples making $100,000 annually or less) and indexing for the future. Permit the AMT to fully "catch" high-income taxpayers in the $200,000-$500,000 range--they are NOT the middle class and they SHOULD be paying higher taxes.
2) Reform the regular tax system by adding brackets to make the system more progressive, with top rates around 55% on those making $20 million annually or more. The CEO who makes in half a day what his average worker makes in an entire year should be paying a much larger share of the tax burden than currently required.
3) Eliminate the section 121 every-two-year gain exclusion on sales of a principal residence. It encouraged the housing boom and bust, without putting more people in homes. Reinstate the rollover requirement of old law, except for seniors who are downsizing.
4) Cut back the section 163(h) home mortgage interest deduction by lowering the maximum mortgage on which interest is deductible to $500,000 and eliminating the deduction for home equity indebtedness interest.
5) Eliminate the cap on income that is subject to Medicare and Social Security taxes and assess those taxes against all income sources. While those newly subject to the higher taxes would get some amount of increased benefit, it would not be proportional to the increased taxes paid.
6) Eliminate the capital gains preference and require third party reporting of all gains.
7) Retain and expand the estate tax while at the same time eliminating the tax provisions that permit wealthy taxpayers to plan around the estate tax.
B) Business Tax Issues
1) Provide better resources to the IRS and more responsibility to taxpayers (and their advisers) to get it right.
The IRS has been outgunned by wealthy taxpayers and big corporations for decades. It is time that we gave the IRS enough resources to do its job correctly. That means at least four things:
(i) more money and more personnel for the IRS,
(ii) removal of the provisions enacted in 1998, after hearings that raised sham concerns about IRS abuses, to discourage the IRS from carrying out an aggressive program of tax law enforcement,
(iii) raising the standards for taxpayers and tax advisers to require a "more likely than not" confidence level, and
(iv) eliminating the attorney-client (or attorney-practitioner) privilege for pre-return tax advice.
About the last two.
Congress raised the required confidence level for tax preparers two years ago (foolishly, without raising taxpayers themselves to the same required level), but then it blinked when the ABA and AICPA launched an aggressive campaign of complaints and changed it again. Now both taxpayer and tax preparer need only have "substantial authority" to take a position (or advise a position) on a return. Most consider that to be a 40-45% probability of success on the merits. The MLTN level of confidence (more than 50% probability of success on the merits) was the right answer--Congress just needs to enact it for taxpayers as well as advisers. We should be requiring taxpayers to pay tax according to their good faith view of what the correct answer is, not according to a guess for which they can find some authority and then take their chances on the audit lottery.
We permit many different people to advise taxpayers about the tax laws, so that such advice looks more like business advice than legal advice. (See my article on this in the Florida Tax Law Review, available on SSRN.) The attorney-client privilege, to the extent it is justified, is rooted in the adversarial context of criminal trials, where there is some reason to think that it helps ensure good communications between client and attorney so that the attorney can plan for trial. Such a privilege isn't justifiable in the tax-return and tax advice context. Taxpayers are supposed to report their transactions according to the law and reveal whatever is necessary to permit appropriate auditing of the returns. If we created a MLTN confidence level and eliminated the attorney-client privilege for tax advice, it would go a long way towards ending the widespread abuses of the tax system.
2) Reform international taxation to eliminate loopholes and the ability of large corporations to avoid tax by offshoring IP and other means.
Large multinational corporations have been exploiting the US markets but paying less and less tax, through a combination of Congressionally enacted loopholes (inserted at the insistence of powerful lobbyists) and aggressive tax planning (offshoring of royalty income through creation of post-office-box subsidiaires in the Caymans or Bermuda, aggressive use of transactions with foreign banks as accommodation parties, etc.). These corporations lobby through various influential coalitions--like the Tax Relief Coalition, consisting of the U.S. Chamber of Commerce, the National Association of Manufacturers, and the Business Roundtable--who bamboozle our representatives into thinking that the companies won't be able to compete globally without being allowed to pay minimal taxes here (and minimal taxes overseas as well). As my colleague Mike McIntyre has argued in a couple of recent articles, it's time for Congress to eliminate the ability of these corporations to hide income offshore by creating a transparent system that requires the identification of beneficial owners. That means that Congress has to refuse to listen to the various financial intermediaries (big banks and accounting firms) that have successfully blocked efforts to create a more transparent system--look at the "qualified intermediary" rules for withholding that permit foreign banks to act on behalf of others without identifying them to the U.S. government. Those banks and accounting firms have failed to self-regulate, and should not be permitted to continue to stonewall the ability of the US to track ownership of income. There are two types of changes that need to be made: (i) create a fully transparent ownership reporting system, where every financial intermediary must report the beneficial owner for whom it acts and whatever information about that beneficial ownership at its disposal (i.e., basis, gains, etc.) and where every beneficial owner must fully disclose all assets held outside the United States and (ii) retune the world-wide taxation system for multinational corporations to prevent their ability to reduce US taxes by moving IP offshore and similiar shams. Finetuning would include such things as restoring the multiple foreign tax credit baskets; eliminating the active financing exception to subpart F income for banks (this was done in 1993, but the banks and their lobbyists have talked Congress into a one-year extension every single year since, initially as a "transition" but now outright lobbying for a "permanent" exception); renegotiating treaties to stiffen taxation (especially of royalties and dividends); clamping down further on abusive transfer-pricing schemes (especially payment of royalties to offshore subsidiaries to which IP developed in the US is "sold" to avoid taxation). (Read McIntyre's article for more along these lines.)
3) Consider revamping the reorganization provisions to make tax-free consolidation of enterprises more difficult.
Big banks (think Citi) and big insurance (think AIG) that are "too big to fail" end up privatizing gains and socializing losses. We should rethink the various incentives in the Code that encourage mergers and consolidations of enterprises--the tax-free reorganization provisions under section 368 and the spinoff provisions under section 355. The Treasury has spent the last eight years making reorganizations less taxing (both figuratively and literally). Maybe it's time to go back the other way. It's not clear that there is any social benefit to encouraging reorganizations through the tax code, other than bankruptcy and similar restructurings.
Are any of these changes feasible? Maybe. I'm not terriblly optimistic, since Congress has lately acted as a pipeline delivering tax wants to Big Banks, Big Oil and Big Multinationals. The American public, it is clear, is fed up with the need to bailout big banks that made huge profits during boom years, paid their executives exorbitantly, and now have received $350 billion of bailout funds from the federal government and are hording it (for opportunistic acquisitions or whatever), often with upfront statements that they have no obligation to the American public because of the bailout. The Democrats will have to display a little spine, and all in Congress will have to set aside their desire to build huge reelection kitties funded by the very groups that should be targeted for tax increases. Rangel (House Ways & Means) and Baucus (Senate Finance) in particular are too besotted with their cronies at the big banks (like Robert Rubin and Hank Paulson). They need to get out of the Beltway and beyond the range of the financial intermediaries, wealthy buddies and stale Clintonite economic advisers. They need to listen to Joseph Stiglitz instead of Larry Summers, Citizens for Tax Justice instead of the Tax Foundation. In other words, they need to breathe some fresh air that is not tainted with the same old Washington think-speak that relies on the old free marketarian nonsense to talk about tax policy. They should read Anne Alstott (Is the Family at Odds with Equality? The Legal Implications of Equality for Children, Harvard, 2008), who dares talk about "equal material provision for children," and Lily Batchelder (Estate Tax Reform: Issues and Options, NYU Draft 1/2/09), who notes that now--with the economic recession and the bizarre disappearance and rebirth of the estate tax enacted by the Republicans under Bush--is the time to reinvent the estate tax as an important contributor to progressivity that can offset the obscene advantages of inherited wealth in this country.
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