Federal Income Tax Restructuring

By Wallick, Ruth | Government Finance Review, December 1995 | Go to article overview
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Federal Income Tax Restructuring

Wallick, Ruth, Government Finance Review

While much of the public's attention to reforms called for by the 104th Congress has focused on the "Contract With America," proposals for a major restructuring of the federal income tax system have begun to be noticed. Few people expect that a comprehensive tax reform bill will be enacted in the very near future, but several committees of the Congress have begun hearings on various tax proposals, and a special commission--the National Commission on Economic Growth and Tax Reform, appointed by Senate Majority Leader Robert Dole (R-KS) and House Speaker Newt Gingrich (R-GA) and led by former Housing and Urban Development Secretary Jack Kemp--has held hearings around the country and is expected to issue a report later this year. Whatever form a major tax restructuring takes, it will have an impact, perhaps more profound than that of the Tax Reform Act of 1986, on how state and local governments raise the funds necessary to maintain their public services, finance their infrastructure, and provide benefits to their employees.

The Proposals

Recent federal income tax reform proposals generally fall into two categories, a "flat tax" that replaces the current graduated federal income tax and some form of a consumption tax. Following is a brief description of the proposals that have so far received the most attention.

Flat Tax Proposals. The "Freedom and Fairness Restoration Act of 1995" has been introduced in the House of Representatives (H.R. 2060) by Majority Leader Dick Armey (R-TX) and in the Senate (S. 1050) by Sen. Richard Shelby (R-AL). Under this proposal, all wages, salaries, and other direct compensation, less personal exemptions of $10,700 for single filers, $14,000 for single heads of households, $21,400 for married couples, and $5,000 for each dependent, would be taxed at a flat rate of 20 percent in the first two years and 17 percent thereafter. Earnings from savings and investment, including interest, dividends, and capital gains, would not be subject to taxation. No other deductions, exemptions or exclusions would be permitted, including home mortgage interest, state and local taxes, and charitable contributions. Businesses would be taxed at the same flat rate on gross revenue less purchases of goods and services, capital assets, and wages and salaries paid. No deductions would be permitted for indirect compensation, interest or dividends paid, or capital losses incurred. Interest and dividend income and capital gains earned would be exempt from taxation.

A variation on the Armey-Shelby proposal has been introduced in the Senate (S. 488) by Sen. Arlen Specter (R-PA) with a companion bill in the House (H.R. 1780) introduced by Rep. Mark Souder (R-IN). Under this proposal, the tax rate would be 20 percent, standard deductions would be lower, and additional deductions would be allowed for charitable contributions up to $2,500 per year and interest on home mortgage loan balances up to $100,000.

House Minority Leader Richard Gephardt (D-MO) recently unveiled the broad outlines of a "flatter" tax. His proposal would flatten the income tax rate structure, lower to 10 percent the marginal tax rate for most individual taxpayers, and eliminate almost all exemptions, credits, and preferences, including the exemption of municipal bond interest. Itemized deductions would be eliminated except that for home mortgage interest. Adjustments would be permitted for certain payments, such as alimony, half of the self-employment tax, investment interest, and job-related expenses. The adjustment for contributions to an individual retirement account (IRA) would be eliminated, although income earned from existing IRAs would remain tax-deferred until it was withdrawn. A personal exemption would be retained, but no deductions would be permitted for state and local taxes paid or for charitable contributions.

Consumption Tax Proposals. The consumption tax proposal that has received the most attention is the "Unlimited Savings Allowance Income Tax" proposal (S.

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