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September 14th Individual Tax Reform

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Overview: A substantive, bipartisan hearing was held today on Individual Tax Reform by the Senate Finance Committee. Among other individual issues, the child tax credit was discussed in depth by Senators on both sides of the aisle and the witnesses. Almost everyone agrees the child tax credit should be increased, or at the very least protected, but the hearing participants found their differences in the methods of funding this tax credit.

Witnesses:

Ms. Lily Batchelder, Professor of Law & Public Policy at New York University School of Law and Affiliated Professor at New York University Wagner School of Public Service
Mr. Alex Brill, Research Fellow, American Enterprise Institute
Ms. Iona C. Harrison, Senior Vice President, Pioneer Realty
Mr. Ramesh Ponnuru, Visiting Fellow, American Enterprise Institute

Opening Statements:

Chairman Orrin Hatch (R-UT): He is ready to work on a bill to reform the outdated tax code. He has been discussing various proposals with WH and Congressional leaders, but maintains that the tax writing committees will be the ones that write the actual legislation. His goal is to produce a bill that will get through the Senate Finance Committee. Any bill, especially one as consequential as tax reform, will require the assistance of all members. He intends to work together with Democrats. He has no desire to exclude Democrats or pass a bill along a party line vote.

Ranking Member Ron Wyden (D-OR): Democrats share the view that the tax code in this country is not working for millions of Americans. Wyden wants to create a tax plan that will help the middle class, the drivers of the American economy. However, he is upset that while yesterday the President announced that he would not give any breaks to the wealthy, the tax plan he released today included an incredible loophole that allows wealthy Americans to abuse the ‘tax pass-through,’ which is supposed to help small businesses. He is additionally against removing the Estate Tax. Wyden wants to work together to create a fair, bipartisan plan to reform the tax code.

Witness Testimonies:

Ms. Lily Batchelder: First, the current tax reform effort is occurring at a time when low and middle-income families are facing deep financial challenges. Economic disparities are vast and have been widening for decades. Our debt is expected to grow to unprecedented levels. This will be a drag on economic growth. For this reason, tax reform should be focused on increasing revenues and progressivity. Tax reform, at a bare minimum, should maintain the current levels of revenue and progressivity. Second, individual tax reform should focus on levelling the playing field for the next generation. The EITC should be expanded – especially for workers without dependents, refundability of the child tax credit should be increased – particularly for young children in the poorest families, and child care benefits should be restructured to provide the largest benefits to those spending the largest share of their income on childcare. This should be done by raising taxes on the wealthy, including by strengthening, not repealing, the estate tax. Third, individual tax reform should focus on reducing transactional complexity. All labor and capital income should be subject to the Medicare tax on high incomes. Fourth, individual tax reform should seek to make tax incentives more efficient and fair, generally by restructuring them into refundable credits and leveraging the empirical findings of behavioral economics. This could generate more social benefits at a lower cost. Finally, the first principle of tax reform should be to do no harm. The President’s proposal and House’s Blueprint do not meet this standard.

Mr. Alex Brill: The tax code has not been truly reformed since 1986. The last 30 years have seen tax complexity increase dramatically. Today’s tax code creates unnecessary burdens on American families. First, the current tax code needs to be simplified. Second, the current individual tax code system treats similar individuals income-wise very differently. This disparity, known as ‘horizontal inequity,’ needs to be corrected. For example, nearly 20% of taxpayers who report ~$36,000 in adjusted gross income pay a higher tax rate than 60% of taxpayers who earn $60,000. Additionally, itemized deductions are generally regressive tax policies. It is estimated that this tax policy forgoes $1.4 trillion dollars. Broadening the tax base is an opportunity to move towards a more neutral tax code. Lastly, the transitionary path will be complex and require lawmakers to strike a careful balance. Failure to do this right will seriously hurt the American taxpayer. Lawmakers have a great opportunity to simplify the tax code, improve the horizontal equity of the system, and reduce economic distortions.

Ms. Iona C. Harrison: Realtors agree that simplification of the tax code is needed. That being said, NAR believes that tax reform that weakens or eliminates the current tax incentives for purchasing or owning a home would be shortsighted and counterproductive. First, the deduction for state and local taxes is vital to a sound tax system – its origins date back to the Income Tax Act of 1861. Second, the Mortgage Interest Deduction is a key incentive to purchasing a first home. Critics often pan it as benefiting the rich, but it is utilized by families of all incomes. It is important to recognize that the value of the current tax benefits of owning a home is imbedded in the price of a home. Without those, home values will drop. Finally, a tax reform plan like the House Blueprint, which doubles the standard deduction while eliminating most itemized deductions, would bring minimal simplification at a very high price for many homeowners, especially those with larger families. The increased child credit does mitigate this somewhat, but that benefit drops off after 16 years of age and larger families. States like Utah could be hurt most where families are larger, home ownership is higher, and itemized deductions are greater than average. Smart tax reform that penalizes homeowners and middle-class families in the name of simplification and lower corporate rates is not worthy of the name – tax reform must first do no harm.

Mr. Ramesh Ponnuru: There is a broad political consensus for tax relief for parents of dependent children. The child credit lifts about 3 million individuals out of poverty each year. Expansion of the credit should be considered. Additionally, the credit should be applied against both payroll and income taxes. The expansion of the child credit should be large enough to make up for a decline of the dependent exemption. A child tax credit expansion would reduce the federal tax distortion. A larger share of the benefits of a child credit expansion would accrue to lower income households.

Questioning:

Senator Orrin Hatch (R-UT): Would repealing the federal itemized deduction for state and local income taxes be a shift in a progressive direction? Batchelder responded that it depends on how that revenue is used. The revenue in the current GOP plans is used for highly regressive tax cuts so, on net, it would make the tax code less progressive. If you repealed it in isolation and used that revenue to expand the earned income tax credit or the child tax credit, that would be a progressive change. Brill responded that repeal on its own is a step towards making the tax code more progressive. Sen. Hatch asked Ponnuru how the child credit expansion will be paid for. Ponnuru responded that the tax credit should be paid for how all other credits are paid for – tax increases and spending cuts elsewhere. He asked the hypothetical question of why child credits are treated differently than other credits.

Senator Ron Wyden (D-OR): Sen. Wyden asked Batchelder to discuss President Trump’s stances on tax reform. She responded that his statement yesterday, that he would not cut taxes for the wealthy, is concerning. In fact, the wealthiest get about half of the tax cuts in his plan. She discussed that his cuts will cause a trillion dollars in revenue losses, which only hurts low and middle income families. To Ponnuru, he asked how he wanted to pay for the child tax credit he wants to expand. Ponnuru responded that he supports dynamic scoring. He wants long-term restructuring of entitlement programs to pay for the expansion. A scaling back of the MID would also make sense to pay for this.

Senator Johnny Isakson (R-GA): Sen. Isakson asked Mr. Brill if we should avoid any clawback on existing tax treatments made prior to the time the tax law was changed. Brill responded that transition issues are huge, especially ones that are retroactive like the Senator’s example. In short, changes should be made on a prospective basis. Isakson believes the best thing the government can do is make sure that Americans can take care of themselves and asked if Brill believed there was any room in the tax code for common sense incentives that promote savings. Brill responded that policies that promote savings are critical to the growth and security of the nation. Senator Ben Cardin (D-MD): Sen.Cardin asked Batchelder to discuss the retirement security front and the impact reform would have on rate reductions. One proposal is to require people to make all their contributions to their retirement savings on an after-tax basis. This has a great impact on whether revenue increases or decreases. You could end up raising a great deal of revenue within the budget window but losing a tremendous amount of revenue outside the budget window. She responded that it is critical that the committee obtain estimates of revenue projections from the Joint Committee of Taxation.

Senator Bill Cassidy (R-LA): Sen. Cassidy asked Brill to elaborate on his position regarding the child tax credit. Brill responded that differences in family sizes create a wide disparity in tax liabilities. Brill would not support blind expansion of the child tax credit.

Senator Sherrod Brown (D-OH): Sen. Brown asked Batchelder what would happen if we raised the age of Social Security eligibility and cutting Medicare while converting our current retirement savings vehicles from a tax-deferred model to a Roth model on middle class families, as the GOP has promoted. Batchelder responded that it would increase the strain on the middle class family. She is very concerned with the Roth model proposals.

Senator Toomey (R-PA): Sen. Toomey wants a pro-growth tax code that will encourage an economic expansion. The tax code is already extremely progressive and will remain so. Asked Brill if it would be fair to characterize his view as that of reductions simply being states with higher taxes subsidizing states with lower taxes. Brill responded that it was an accurate representation of his opinion. Do lowering marginal rates have a nearly immediate, positive effect on changing incentives and therefore encouraging economic growth? Brill responded that lower effective tax rates will increase incentives and growth but when you’re simultaneously widening the base, it becomes more unclear. Base broadening can sometimes neutralize the positive effects of lower rates, though efficiency gains are still made.

Senator Carper (D-DE): Sen. Carper asks four questions about tax reform: is it fair, does it foster economic growth, does it simplify the tax code or make it more complex, and how does it affect the deficit. He asked if the panel agreed these were good questions and they all agreed. He asked the panel about their opinion on the IRS’ budget cuts. Everyone agreed that the IRS’ budget should not be decreased except for Brills and Ponnuru who refused to comment.

Senator Claire McCaskill (D-MO): Sen. McCaskill asked if the panel believed clearing up the complexity of the tax code was equally important as other issues of the tax code. Brill responded that complexity is a major hurdle that must be cleared up. Additionally, he that said burdensome costs, because of the complexity, is a major issue that any substantial tax reform efforts should make an effort to fix. McCaskill asked Harrison whether there are any studies that show a loss of renters if the MID reduction was done away with. Harrison responded that there wasn’t but that it is a policy that has been in the tax code since the 1930s.

Senator Bob Casey (D-PA): Sen. Casey focused on the increasing cost of higher education. Additionally, in 33 states, and DC, infant care costs have risen above the costs of tuition at a public, instate, four year school. Sometimes families can be paying upwards of a fifth of their income on childcare. He asked Batchelder to explain the President’s past proposals on childcare and why a credit for childcare costs is preferable to a deduction. Batchelder responded that the President did come out with a number of proposals regarding childcare but they did not address the challenges. His proposals provided a number of benefits to higher income families, rather than lower income families, and were quite complicated. She supports a refundable tax credit for childcare that is targeted on people who the costs impose the biggest budgetary strain for them. This would require the tax credit to be refundable. Additionally, though not strictly individual tax reform, it would be very helpful to fully fund the direct spending programs for childcare. Currently, only 15% of people eligible are able to claim those subsidies. Particularly for lower income families, those direct spending programs may be more efficient than a tax credit as they are paid out as your childcare bills are due, rather than at the end of the year.

Senator Stabenow (D-MI): Sen. Stabenow supports keeping the mortgage tax deduction. She also wants to highlight that the House Blueprint plan is bad for America and especially bad for Michigan. Stabenow wants to work on a bipartisan basis to reform the outdated tax codes. She asked Batchelder to elaborate on what lessons we can take away from previous piecemeal efforts to reform the tax code. Batchelder responded that it is paramount for tax reform to be done on a bipartisan basis. Not only is it more effective, it is more likely to endure when both parties have their fingerprints on it. Transparency is also crucial. Secondly, she recommends looking closely at the revenue and distributional effects.

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