Tax reform could help solve fiscal crisis

This could be the year for some real tax reform.

The federal government needs to complete its reduction of the federal debt by a targeted $4 trillion over ten years.  Many state governments, which must have balanced budgets, face stubborn deficits.

Tax reform should be part of the solution.

Pure tax reform is meant to be “revenue neutral,” not changing the amount of money government takes in, but making the tax system fairer for taxpayers.

We are not talking about pure tax reform this year.  President Obama wants the wealthy to pay their “fair share” and that means they should pay more.  Meanwhile, there will likely be no more tax cuts for anybody else.

In dealing with the federal debt, the President and Congress have already saved about $2.5 trillion in spending cuts and tax rate increases on high income people, especially those with taxable revenues above $450,000.

More is needed, probably in both spending cuts and tax increases.

The added federal tax money probably won’t come from further rate increases or even by lowering the definition of who is rich.  It will come from closing tax loopholes.

A loophole excludes certain income from being subject to tax.

All loopholes have been created by law with the specific intent of favoring some activity like giving to charity, buying a home or making certain investments.

Of course, loopholes also favor the people, often the most wealthy, who can take advantage of them. 

Some tax breaks come right off the top, even the tax return reveals if a taxpayer passes the $450,000 level.  For example, GOP presidential candidate Mitt Romney’s taxes showed that he received almost $2 million a year that simply did not count as part of his taxable income.

In the new Washington struggles to cut the debt, the Republicans want no more rate increases. If Obama agrees, as it looks like he might, the focus will be on loopholes, yielding a relatively small amount of revenue.

While closing loopholes in addition to spending cuts can help make it look like the $4 trillion goal has been reached, that will be something of an illusion.  Accountants for the rich and famous are already at work relabeling some investment income so it can slip through one loophole just as another is closed.

All that goes to show is that the battle against loopholes is endless and less likely to produce a real debt reduction than would an increase in rates.

It’s likely that everybody in Washington knows that, but is willing to give a somewhat false impression about their success in cutting the national debt.

Many states base their income tax at least partly on the federal system, so whatever happens in Congress will filter through to their state taxes.

But states will probably have to do more, because they cannot hide their debt behind more borrowing as easily as the federal government.  Many need voter approval for taking on more debt.

In a recent statewide referendum, California voters boldly decided to support a tax increase.  That stunned pundits who thought people would never agree to higher taxes.

As a result, Gov. Jerry Brown announced that the state’s budget shortfalls would end, restoring the state to fiscal health.  That’s only possible if the state stays on the straight and narrow.

In Maine, Gov. Paul LePage has reasonably advocated reducing the top income tax rate, among the highest in the country.  Democrats oppose any such rate cut for the rich.

The state’s financial problems cannot be solved by slight decreases or increases in the top tax rate, though such changes might promote greater tax fairness.

If the only fiscal policy is to cut state spending, as LePage advocates, most of the burden will shift to the property tax.   That’s decidedly unpopular.

And there is evidence that property taxes affect real estate sales, important as Maine develops as a retirement and vacation home haven.

The state needs more tax revenues and the obvious sources are increases in the sales tax and the meals and lodging tax.  And, as in other states, fewer items should be exempt from the sales tax.

Lower income people would be sheltered from a sales tax increase by the current exemptions established with them in mind.

Opponents say that such increases would cause sales to fall, and tourists to go elsewhere.  But there is no evidence that’s true. 

During a state budget crisis in the 1990s, Maine temporarily increased the sales tax.  Now might be the time to try it again.