Volcker Tax Reform Report

Back in February 2009, President Obama appointed former Fed chairman Paul Volcker to head a President’s Economic Recovery Advisory Board (PERAB). The Board issued a report on tax reforms last Friday.

Who’s on the Board

The board is largely non-political. Besides Paul Volcker, the Board has as its members a former SEC chairman, a venture capitalist, a representative from AFL-CIO, corporate executives, endowment fund manager David Swensen, university professors, and Obama’s economic advisor Austan Goolsbee.

Scope of the Report

The board was asked to consider ideas that pertain to tax simplification, closing loopholes, and corporate tax reform. The board was specifically asked to exclude ideas that would raise taxes on families with income less than $250,000. So raising taxes broadly to reduce the deficit is off the table. That’s the job of a different commission, National Commission on Fiscal Responsibility and Reform, whose members are mostly elected House Representatives and Senators.

Ideas

Because the Volcker advisory board was asked not to consider any grand scheme tax reform such as flat tax or introducing a VAT, the ideas are only within the framework of the current tax system. I read the entire report (95 pages). I’m in favor of most of the ideas. I list some of the ideas on individual taxation with my comments.

1. Consolidate child related benefits (pp. 8-9)

The child tax credit, dependent exemptions, EITC, and dependent care credit are too complex. Bundling them is a good idea.

2. Consolidate education related benefits (pp. 10-15)

There are 18 education related tax benefits. Who understands them all? Give one benefit and be done with it.

3. Simplify kiddie tax (pp. 15-16)

If a child earns income from wages, I’m in favor of giving the child a larger standard deduction and not withholding taxes from wages. Investment income, however, should be taxed at the parents’ rate from the first dollar. There’s no reason to create complexity with three tiers: first $950 free, next $950 at child’s rate, anything over at parents’ rate.

4. Consolidate retirement accounts (pp. 24-28)

Yes! See previous post Retirement Plans Galore: 401(a), 401(k), 403(b), 457, SEP, SIMPLE.

5. Make everyone eligible for a deductible IRA (p. 28)

Right now whether one can take a deduction for a contribution to an IRA depends on one’s income and coverage by a retirement plan at work. The proposal makes everyone eligible for a deductible IRA but the combined limit for both IRA and employer sponsored retirement plan will stay under the $16,500 limit, meanwhile the IRA itself still has the $5,000 limit.

The proposal didn’t go far enough. It should give a combined limit to all plans and IRAs and that’s it. That’ll be simple, elegant, and it frees people from bad plans at work or not having a plan at all.

6. Consolidate non-retirement savings plans (p. 29)

Here we are talking about FSA, HSA, MSA, 529, and Coverdell. One account for health and another for college seems reasonable.

7. Simplify Social Security taxation (pp. 34-36)

The Board proposed small simplification on taxing Social Security benefits: use two tiers instead of three; not count Social Security benefits in MAGI. It’s too timid. Income is income. Just make Social Security fully taxable.

8. Indexing principal residence exclusion for capital gains (p. 41)

Bad proposal! The exclusion should be eliminated. Treat capital gains the same whether it’s from securities or real estate.

9. A pre-filled return from the IRS for taxpayers with simple returns (p. 43)

It can serve as a good starting point for many. Verify, update, and send. I won’t use it until all the tax complexities are eliminated but it’ll probably help some.

10. Limit itemized deductions and give a larger standard deduction (pp. 44-46)

The proposal only limits itemized deductions. It should eliminate them. It’s already done this way in AMT. It’s much cleaner. The majority of itemized deductions can be eliminated in exchange for a larger standard deduction.

11. Eliminate the AMT (p. 50)

When most of the itemized deductions are eliminated, we can also eliminate the AMT. Calculating taxes twice is insane.

Will these ideas be implemented? I’m not holding my breath. One can always dream, right?

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Comments

  1. tarnation says

    eeww. Bad news on pg 28 for anyone who maxes both their 401(k) and IRA’s. In addition, as pointed out, this adds complexity for individuals to keep track of how much was contributed to each account, which seems counter to the simplification goal.

  2. tarnation says

    eww again on p 38. Eliminate specific share ID for mutual funds and allow avg cost only. Although, separate accounts would be treated separately. So I could still tax loss harvest, just have to keep each tax lot at a different custodian! :) I imagine this recommendation has a higher probability of making into law to make it easier with the new reporting guidelines.

  3. Harry Sit says

    tarnation – Every little break in the current code has its advocates. In the grand scheme of things, I’m willing to give them up for a simple to understand system. Tracking basis by lot is too complex. How many times have we heard people having no idea what their basis is in a basket of stocks? Tax loss harvesting can be seen as a loophole that should be closed.

    I’d take one combined limit for 401k and IRA over the test for income, filing status, and coverage under an employer plan. The combined limit doesn’t have to be $16,500. It can be $21,500, or $19,000, whatever, but make it combined, and make it indifferent between IRA and 401k.

  4. tarnation says

    If I read correctly, the proposal did not say stocks just mutual funds. So we are not going to go away from tracking lots. Makes me wonder which treatment ETF’s will receive? I don’t really see TLH as a loophole nor see a way to eliminate it unless we can no longer deduct losses??

    One limit seems fine with me shared between 401(k), TIRA, Roth, but I would like to keep the ability to save at current levels, not less.

    AMT seems like a mess. If I understand, the problem is the AMT amounts were not indexed to inflation, so it wound up capturing income it shouldn’t have. However, now when they talk about fixing it, they talk about how much it will cost, or want it to be revenue neutral. That was money they were not supposed to get in the first place, why would it be revenue neutral?

  5. Andy says

    Since social security tax is not deductible, why do you think the benefits should be taxed again? It’s kind of like buying an annuity using post-tax money, and then count the entire amount of each annuity payment as income. Doesn’t sound right to me…

  6. Andy says

    Actually, let me correct myself. I think the employer part of the contribution is deductible for the employer. Still, that means part of the social security benefit should be taxable, not the entire amount. Specifically, I think the amount that I contribute from my own salary should NOT be taxed again.

  7. Harry Sit says

    @Andy – Social Security tax and benefits are unrelated, according to a Supreme Court decision. The tax you pay when you work pay for benefits to seniors at the time. The benefits you receive when you retire are a gift from the folks still working.

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