Newswise — Mount Holyoke professor John Fox is a featured expert in the recent documentary, "An Inconvenient Tax," which focuses on the income tax, tracing its history and detailing its flaws and how it could be reformed to promote fairness and economic growth.
Fox, who practiced tax law in Washington D.C. for many years, teaches a seminar on United States tax policy, Winners and Losers, at Mount Holyoke.
He offers five commonsense “keys” to help students, and the public, analyze the impact of tax breaks that appear in our federal income tax laws:
1. You can’t think about tax breaks without considering their impact on tax rates.
“Most tax breaks drive up tax rates,” Fox says. “The IRS can’t tax what’s not there, and every tax break reduces the amount of income the government can tax--called ‘the tax base.’ The smaller the tax base, the higher tax rates must be on all the remaining income in order to raise a given amount of revenue. In other words, there’s no free lunch. Conversely, as Congress reduces tax breaks, it can reduce tax rates without losing revenue.”
2. It matters greatly whether a tax break is in the form of an “exclusion” or “deduction” versus a “tax credit.”
“Every dollar of exclusion (such as for health insurance premiums paid at work that are excluded from your tax return) or deduction (such as for home mortgage interest) provides the greatest savings for taxpayers in the highest marginal bracket and the least savings for taxpayers in the lowest marginal bracket,” Fox says.
Consider a $1,000 exclusion or deduction: your tax savings is $350 if you are taxed at the top 35 percent bracket, while your tax savings is only $100 if you are taxed at the bottom 10 percent bracket.
“On the other hand, if you are entitled to a tax credit of $1,000, you save $1,000 of taxes as long as you owe at least $1,000,” Fox says. “Thus, tax credits are equivalent to government grants and make the most sense if the government is trying to provide at least equal help to ordinary households as to higher-income households. Tax exclusions and deductions, on the other hand, provide the greatest savings for people who need government help least, and the least savings for people who need government help most.”
3. Conservative and liberal economists agree that our economy would be stronger if Congress limited tax breaks to those absolutely essential.
“High tax rates--paired with vast opportunities to avoid them--encourage legal and illegal avoidance,” Fox says. “Lower tax rates paired with few opportunities to avoid them encourage households to spend and save in ways that focus less on tax outcomes and more on real economic outcomes.
“Fewer tax breaks also increase tax compliance, reduce compliance costs, and increase the capacity of the IRS to enforce the laws.”
4. Far fewer tax breaks would make it more likely that equals would pay equally, thereby increasing public confidence in the fairness of the tax system.
“A basic principle of fairness in the tax laws is that equals should be taxed equally,” Fox says. “The vast number of tax breaks that allow almost half of all individual income--nearly $5 trillion this year--to avoid taxation makes it unlikely that households of equal size with equal income will be taxed equally.”“With far fewer tax breaks, households of equal size with equal income will be taxed equally most of the time.”
5. Tax breaks for some make those who don’t get the tax breaks worse off. They become double losers.
“It’s often said by proponents of tax breaks that ‘It’s just a tax break. If you don’t get it, you are no worse off.’ But tax breaks often drive up the price of whatever is involved,” Fox says.
As an example, he says, tax laws allow the payment of all health insurance premiums through work to be excluded from an employee’s tax return, even for the most expensive policies.
“Economists agree that the blanket exclusion, by increasing the demand for health insurance and for medical services, drives up the price of all health insurance premiums and health care costs generally,” Fox says. “While most workers obtain their health insurance through work, millions do not. And for them, the exclusion makes them double losers: they don’t receive the tax benefit, and the price of health insurance and health care is even more expensive than it would be without the exclusion.”
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