This week, leaders of a special bi-partisan White House Commission on Deficit Reduction released some of its preliminary recommendations. The recommendations, to be finalized next month, touch on hot-button issues such as the federal tax code (particularly the mortgage interest deduction and tax brackets), military spending, the corporate income tax, and social security. Interest groups on both the Left and Right immediately criticized those areas where their particular ox was gored.
But frankly, we think the Obama Commission is on the right track, and the suggestions deserve support. In fact, if anything, we think the proposal can be made even bolder than it is (My friends who are anti-tax advocates, real estate agents, and home-owners are screaming, "What?!?!?") We will attempt to address these in a series of separate posts. Today, we tackle the mortgage interest deduction and tax brackets.
Here are the Facts: The federal government's financial state has never been worse. EVER.
The current National Debt - the amount our expenses have exceeded our tax revenues - is at 13.7 trillion dollars. To put that in perspective, the total value of all the goods and services created in the United States over the course a year (our GDP)...is between 13 and 14 Trillion....which means our debt is as great as everything we are capable of producing. Or, put another way, the debt is $42,000 per man, woman, and child in the US.
And that is just the current debt. Since the US actually borrows money to engage in deficit spending, interest is continually added to this figure. Currently, almost 25 cents of every tax dollar goes simply to pay the interest on this debt. That's 25 cents that could otherwise be used for actual productive purposes...instead, that interest is paid to institutions enormous enough to be able to lend money to the US government to fund its deficit spending: The government of China, Goldman-Sachs, Lloyds of London, Credit-Suisse, the House of Saud, Morgan Stanley, and Citibank.
As long as we continue to pay interest like this, we are institutionalizing a situation where wealth leaves the hands of the general citizenry and is concentrated in the hands of those who already have enormous wealth. In other words: The rich get richer, while the poor - and the middle class, and our children - get poorer.
NEVER have we been this close to a financial catastrophe. And the time for playing politics is over.
According to the Wall Street Journal, "...The preliminary plan in its current form would end or cap a wide range of breaks relied on by the middle class—including the deduction for home-mortgage interest....To compensate, one version of the plan would dramatically lower and simplify individual rates, to 9%, 15% and 24%.."
Let's take these one at a time.
Home Mortgage Interest Deduction: This is one of the favorite income tax deductions used by middle class, home-owning Americans. (I wonder how many homeowners who are worried about the federal deficit will be willing to support changes in their personal sacred cow?)
The Federal Income Tax is, supposedly, a "Progressive Tax," meaning that the more money you make, a higher percentage of that income is paid in income tax. Of course, that's the theory...in reality, the use of deductions like the Home mortgage interest deduction actually reverses this, and places a higher tax burden on those with less wealth.
When a new mortgage is made for a home, the homeowner pays mostly interest in the earliest years. A new mortgage that runs $1500/month, for instance, might be as much as $1,400 interest and $100 in principle each month. The portion that represents interest is deducted from the homeowners gross income before the tax rate is applied. In the above example, a family earning $50,000/year could have an annual deduction of $16,800, reducing their taxable income to $33,200. The same family, if they were renting their home for $1,500 month, would have a deduction of ZERO. The Home Mortgage interest deduction results in penalizing those with fewer assets and rewarding those who already have wealth in the form of real estate assets. Rather then being a "progressive" tax, this deduction creates the opposite result.
In addition to these two families having different "taxable income," the renter may actually have to pay a larger tax rate because of the Federal Income Tax "Brackets:" A family making over $68,000 is taxed at 25%, while a family making $67,000 is only taxed at 15%. As a result, the mortgage interest deduction has become an almost necessary deduction used by American families to push them down into lower tax brackets to avoid punitively high taxes...again, at the expense of those who rent, or who bought their homes years ago, and have no such deductions, who must pick up the slack.
Bottom line: if Americans are to 'get on board' with the elimination of the mortgage interest deduction, they must first be convinced that it is part of a comprehensive tax reform package that is not going to drown them in taxes.
Tax Brackets: The Federal tax code currently utilizes six tax brackets: 10%, 15%, 25%, 28%, 33%, and 35%. The commission is proposing reducing this to only three tax brackets: 9%, 15%, and 24%. This still leaves the problem that taxpayers will seek deductions to 'push' them down into lower tax brackets. The time has come for a long-discussed, long-overdue idea: a simple Flat Tax. The commission (and more importantly, Congress) should be convinced to eliminate tax brackets altogether, and use a simple percent applied to income, with no 'deductions' for special vested interests.
A legitimate argument against a Flat Tax is that those at the very lowest end of the income earning spectrum are hurt. Not only are they unable to meet basic needs of shelter, heat, clothing, food, transportation, and health care...now they would need to pay 10% of what little they make to the government, further impoverishing them.
This could actually be addressed with one simple adjustment to the Flat Tax.
Each year, the Federal Government determines the 'poverty' level; in 2010, for a family of 4, that figure is $22,050. If one agrees that no family should be pushed into poverty because of taxes, then A Flat Tax could be applied to Gross Income less the poverty level income amount for that year. In other words, our family of 4 above, making $50,000, would subtract $22,050 from their gross income, and be taxed on the remaining $27,950. If the tax rate was a flat 15%, that family would pay 4,192 in taxes, regardless of whether they owned or rented. A family earning less than $22,050 would pay nothing; a family earning $200,000 would pay $30,000.
Simplification of the tax code by enacting a single Flat Tax rate, applied only to earnings above the poverty level, would eliminate the need for taxpayers to seek out special deductions, make the federal income tax far more equitable than it currently is, and help move us back on a track towards fiscal sanity.
Of course, now that we have hopefully calmed some of the real estate agents fears, the accountants who thrive on the Byzantine tax code will be up in arms....
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