DRAFT: This module has unpublished changes.

Gabriella Barnes

Public Finance 

Exercise #2 

In response to the growing U.S. deficit, I have made a proposal to aid in the solution of controlling the Federal debt. I firmly believe that with tax reform we can achieve a $300 billion reduction in this federal deficit by 2020.  If we follow the guidelines listed below, the revenue raised by reforming our current tax code can be used to reduce our federal debt.

One: Limit the tax benefit of itemized deductions to a flat 15 percent. In limiting the total percentage for these itemized deductions more income will be subject to federal taxes and thus increase revenues by $150 billion. For example, a family with an income of $100,000 will only be able to claim a total deduction of $15,000 on their federal taxes. Thus $85,000 of their income will be taxed at the new flat MTR. That means at $85,000 the families total taxes would be $13,865 at the federal level and their marginal tax rates would be about 25%. The 15% ($15,000) deduction is slightly above the standardized deduction for married couples filing jointly which is $11,900, a small increase, slightly less than two thousand dollars, for higher income couples. At this point, the lower income families could use the flat 15% tax to decrease their tax obligation. In the case of higher income families, the family using this marginal tax rate would have their tax payments increase because they now have a limit on the amount they can deduct. As far as equity goes, if you earn $100,000 you are more able to pay higher taxes than someone making $60,000. Yes, in both cases, MTR’s would increase but it would make the wealthy pay more of their income to federal taxes. I choose to reform the itemized deduction to a flat 15% because a uniformed 15% rate will increase revenues, decrease debt and place a more equitable tax liability on the various income brackets.

Two: Eliminate the deduction for state and local taxes. Many tax payers deduct state and local taxes on their income tax. However, if this wasn't an option, many would have higher MTR’s. Now, for example, our $100,000 income family can make an extra $10,000. Their federal tax MTR is 25% and their state is 5%. Through the deduction process the family is decreasing their Marginal tax rate by 1.25% thus decreasing their total Federal MTR from 25% to 23.75%. Now the family’s total MTR (state and federal) is 28.75%, down from the 30% that it was originally. As far as equity, this plan increases MTR’s for everyone but families with higher incomes would be affected more because they would no longer have as large a tax deductible.  Others may not see this plan as equitable since many lower income families do not have enough expenses to use this deduction, but they can still take off mortgage interest and other deductions from their taxes. This would raise about $110 billion in tax revenue and decrease the overall Federal deficit tremendously. Together, these two reforms will reduce the Federal deficit by $260 billion by 2020. 

Three: Curtail the deduction for charitable contributions. Families with higher incomes generally give large sums of money to charities in order to increase their deductions and decrease their MTR’s. In eliminating this contribution, larger marginal tax rates will directly target the wealthy with less impact on the middle or lower class. Charitable contributions have been a great way for the wealthy to reduce their taxable income by making their income fit into lower tax barracks and  lowering their MTR’s. For example, a family with a $80,000 income makes a $10,000 donation. Their taxable income is now $70,000 and that moves them out of the 25% tax bracket into the 15%. The $80,000 income family would then be in the same tax bracket and have the same MTR as a $30,000 income family with no charitable donations. Yes, the $30,000 family would still pay less taxes because they have less income to tax but the rate would be the same as for the $80,000 income family. Overall this suggestion would raise around $30 billion in revenue by 2020. Many can argue this isn't a large sum of money but it also deals with equity concerns. Charitable donations are a gift to the less fortunate, they shouldn't be used as a reason for tax avoidance and lowering MTR’s. Charity in itself should make you and the receiver feel good and these contributions should never have been used for tax deductions in the first place. Donating your money to a charity to keep more money for yourself is a form of manipulation and not equitable. Furthermore, this deduction wouldn't be eliminated but rather curtailed so that only a portion of your charitable donation would be tax deductible.  This would bring  an  additional revenue of $30 billion dollars by the year 2020. 

Fourth: Use an alternative measure of inflation to index some parameters of the tax code. This is basically an option for the federal government to change the code for inflation from  the traditional CPI-U to a chained CPI-U, which has a lower annual rate that is 0.25 of a percentage point less than the traditional CPI-U. Basically, this reform is the smallest portion that taxes can be raised without a significant increase in an individual’s taxes. Because the 0.25 of the percentage point less tax rate is distributed among a larger portion of the population, it raises the last $10 billion in revenue needed for reducing the growing U.S. debt. This would increase MTR’s slightly as well as the total amount of taxable income. Again, this is equitable because it is spread amongst everyone.  Also, it is new revenue that we need. I picked this option because the increase in MTR’s is so insignificant to the individual in the total tax population that it wouldn't upset many people and it raises enough revenue because it  increases total taxes received without negatively impacting any equity issues. In total, my purposed tax reform  proposal  has raised the $300 billion from taxes.

My rationale for picking these revenues is simple, they can create the most revenues in a short amount of time which is efficient. In all the cases listed above, marginal tax rates are kept the same, and the number of tax brackets are remain the same. By eliminating some deductions, we can increase the income subject to taxes, keep tax rates the same and increase revenues for our debt reduction. All I am purposing is an increased in taxable income at the same marginal tax rates. Eliminating some deductions and more regulation of  other deductions means higher taxable dollars for the Federal government to collect. 

In today’s world, growing up in an unstable economy, I would be opposed to eliminating any tax, especially one on personal savings. To be clear, I would enjoy having more money in my pocket and having fewer taxes to pay but understanding the ramifications of the U.S. deficit, I know revenues are going to have to be raised one way or another. By taxing personal savings, you get additional revenue to decrease our overall debt. I would have to stick to the formal income tax system rather than a consumption tax based on what we consume and buy. In the near term, a conversion to a consumption tax would increase the deficit. Marginal tax rates would be much lower for a majority of the population and therefore the Federal Government wouldn't have as much revenues. More people have a lower taxable income as this recession continues and  if we switched from an income tax to a consumption tax, our tax revenues could decrease and any estimates of tax receivables are educated guesses and cannot be relied on.

DRAFT: This module has unpublished changes.