The primaries are nearly over and the focus will soon turn to the two parties and policy differences leading up to the November election. Tax reform is certain to be one of the top issues. A proposal was recently introduced in the House that would simplify the tax code and reduce tax rates down to two brackets – 10% and 25%. This proposal would also get rid of the alternative minimum tax, which is plaguing us again this year.
Having just two tax brackets is a wonderful idea, but certainly not a new one. Keep in mind that this is not a tax cut, it’s tax simplification. In order to reduce tax brackets to two low rates they have to eliminate some deductions in order to stay revenue neutral. This will mean cutting or eliminating two of the most popular deductions – state and local taxes and the mortgage deduction.
A simpler tax code that has only two tax brackets was attempted 25 years ago. The Tax Reform Act of 1986 (TRA86) had similar objectives. The two proposed rates were 15% and 25%. In order to drop the top rate to 25%, they had to eliminate the deduction for state and local taxes which turned out to be a sacred cow. The compromise bill raised the top rate to 28%. TRA86 also tried to limit the mortgage deduction, but that too turned out to be a sacred cow. The compromise that resulted limited the deduction by putting a ceiling on the loan amounts for a first mortgage deduction and home equity lines of credit.
It is unlikely that any meaningful tax reform bill will be passed before the election. However, whenever Congress gets around to this issue, they will need to gore some of the popular sacred cows if we want a simpler, flatter income tax. Keep this in mind when your favorite deduction is on the chopping block.