Monday, April 30, 2012
The most recent Congressional Budget Office forecast for the federal budget estimates that the federal deficit will decline to about 1% of GDP a decade from now. But this essentially rosy forecast is predicated on the expiration of all current temporary tax policies – in particular, the 2001/03 personal income tax cuts – and a reversion to pre-2001 tax law. We argue that revenue collections of the same magnitude as those projected by the CBO are necessary over the medium term. But certain aspects of current tax law are problematic, and the efficiency and equity of current law’s scheduled post-2012 tax system can readily be improved.
We therefore develop an alternative post-2012 personal income tax regime, the “Better Base Case.” This proposal contemplates modifying current law by limiting personal itemized deductions to a 15% tax rate benefit, and then “spending” the resulting incremental revenues to (1) permanently patch the AMT, (2) tax dividends at the same preferential rates as net capital gains, (3) restore the estate tax to 2009 rates and exclusion and (4) restore the child credit to its current levels. Using the Tax Policy Center’s microsimulation model, we demonstrate that this package of reforms is revenue neutral compared with current law, and is slightly more progressive in its distribution of tax burdens. We further consider the political economy implications of the proposal, and conclude that the Better Base Case is a logical and feasible next step in the evolving debate over the size and financing of the federal government.