Time to Fix the Tax Mess – A Centrist Path to More Tax Revenue

Article #13 Purple Wayz: Navigating to the Center

We’ve been diving deep into the murky waters of federal debt and the urgent need to right our fiscal ship. Because DOGE and Tariffs are so topical, we took a couple of detours to explore them. As a reminder, PW applauds DOGE’s goals but critiques its sledgehammer approach. DOGE might yield $200B in spending cuts, which puts a needed dent in the deficit, but that isn’t nearly enough. With tariffs, PW likes the attempt to level the playing field, but the sledgehammer approach was poorly advised. And Trump did a lot of damage to our reputation and relationships. He capitulated fast, as the bond market gave him a quick reminder of economic realities.

The US is about to start another tax debate as the Tax Cuts and Jobs Act of 2017 (TJCA) is either renewed or adjusted this year. To be clear, raising additional tax revenue is not on the table with this all Republican group. We’ll get a reconciliation that extends the TJCA, with some tweaks. Trump is also on record multiple times that he will not touch the major Mandatory Expenses like Medicare and Social Security. This conversation is about what could happen in future administrations that are more serious about deficit control.

So let’s talk about taxes! Yeah, baybee!

Tax Myths Tax talk gets everyone riled up, largely because of the many misunderstandings out there. I encourage you all to read Jessica Riedl’s article called Correcting the Top 10 Tax Myths. This is so on point that I’ll say it again: READ THIS PIECE! She also does a great interview on the Freakonomics podcast. If you don’t reverse your opinion on at least 3 of your long held beliefs, I’ll be shocked. Many of you will have to seriously question your entire understanding of this admittedly VERY BORING area.

Myth 1: “Tax Cuts Pay for Themselves”

Myth 2: “Tax Cuts Will Starve the Beast”

Myth 3: “The Middle Class Pays Higher Tax Rates than the Rich”

Myth 4: “Those Old 91% Tax Rates Raised Large Tax Revenues”

Myth 5: “Europe’s Higher Tax Revenues Derive from Aggressively Taxing the Rich”

Myth 6: “Tax Cuts for the Rich Drive Soaring Deficits”

Myth 7: “Taxing Millionaires and Corporations Can Eliminate the Deficit”

Myth 8: “Most of the 2017 Tax Cuts Went to Corporations and the Wealthy”

Myth 9: “Replacing All Post-1980 Tax Cuts Provides Painless Deficit Reduction”

Myth 10: “America’s Corporate Taxes are Far Below International Standards”

She also adds a ‘Bonus Section of Smaller Myths’ like “TCJA Dramatically Raised Low-Income Taxes” and “Payroll Taxes Fund All of Medicare”.

PW’s Approach Here’s a high level approach to Tax Reform that would balance the need to preserve growth with the need to raise about $400B more annually, in 2024 dollars. We’ll go into each of these in more detail in the coming articles. Please refer to the chart below as a reminder of the size of each component.

1. Attack the Individual Income Tax Loopholes and ‘Tax Expenditures’: PW likes the simple idea of capping total deductions. That way, Congress doesn’t have to abolish all the cherished loopholes like mortgage interest, which is a political nightmare. This is progressive. That said, it’s not a panacea. Right now only 9% of taxpayers are itemizers. Two thirds of these people are high earners–over $500k. So it’s progressive, but it only gets you so far.

   But there are lots of tax expenditures out there too. Here’s a biggie: exclusion of employer contributions for medical insurance from income. These premiums are deducted by companies; but they’re not treated as income to employees and therefore not taxable. This tax distortion is a primary reason why the price of healthcare has skyrocketed, especially in the commercial (non-Medicare and Medicaid) realm. If you adjust this in a thoughtful way, you get much better incentives and $50 billion more tax revenue per annum according to the CBO. Because it would be unpopular, it would take a bipartisan approach to avoid the usual problem where the initiator gets his head chopped off.

2. Further Simplify the tax code: There has been lots of talk about ‘Return-Free Filing’. Its time has come. This would be HUGE. Wouldn’t add much revenue. But oh man, would it be appreciated.

3. Modernize the Capital Gains Tax: A rate around 25% is revenue-maximizing. Anything higher, and people work to avoid it. They wait to sell, borrow against the asset, hedge it, etc. Anything lower, and the take isn’t quite enough. Since this is only slightly higher than the current 20%, the impact is moderate. But every little bit helps....Related, you could…

4. …Modernize the Estate/Death Tax: In 2023, the federal government received $34 billion in estate taxes. In that same year, the federal government missed out on approximately $62 billion in capital gains taxes due to the basis step-up rule at death. Example: Jim’s Dad died today. He had bought 500 shares of Microsoft at $21 for about $10,000 in 1998, but smartly never sold it. Jim inherits the stock. But even better, he gets a ‘step-up’ on its tax basis to today’s price of $385. It’s now worth $192,500! The family saved $43,000 in capital gains taxes by waiting to sell MSFT all these years! Jim will sell it tomorrow and pay no taxes. And he’ll then throw it into the job-generating company he always wanted to start! Let’s look at death holistically and come up with a better plan that raises a lot more revenue and reduces silly frictions.

5. Address Payroll Taxes Sensibly: Social Security and Medicare are vital, but their long-term sustainability is a concern. One way to shore up their finances and increase revenue is to extend the income levels subject to payroll taxes, gradually raising the cap beyond the current level. That said, any Grand Bargain is also going to include benefit reform (i.e. raise the eligibility age, lower the benefits per person).

6. Corporate Tax Reform: The focus should be on eliminating loopholes and deductions that allow for excessive tax avoidance, rather than simply hiking rates to non competitive levels. A clean sweep of these tax expenditures, as envisioned in Simpson-Bowles, could boost revenue without harming competitiveness. There are hundreds of them in corporate tax land. Two classic tax expenditures are capital gains treatment on carried interest in the Private Equity and Venture Capital sector, and exempting Credit Unions from Federal taxes. A fellow Substacker Adam Michel recently put together a Bracket for the worst tax expenditures. It’s kinda fun, if you’re into this kind of thing..

Now, Celeste the Centrist would remind us that even the best tax plan is useless without the political will to enact it. This is where Purple Wayz’ emphasis on electoral reform comes into play. As long as our political system is dominated by a two-party duopoly incentivized to cater to the extremes, comprehensive tax reform that involves shared sacrifice will remain elusive.

Open primaries, ranked-choice voting (RCV), term limits, and gerrymandering reform are crucial tools to empower centrist voters and elect representatives willing to compromise and tackle tough issues like tax reform head-on.

Did you notice something about the Republican Senators who opposed Trump’s tariffs? Two of them were voted in using RCV (Murkowski and Collins) and one is a lame duck (Mitch McConnell). The other is Rand Paul, a long time free trader. Murkowski and Collins are more beholden to their states’ overall electorate than their party’s base. McConnell is simply free to vote his conscience because he’s not trying to get re-elected. This positive incentive would exist with a much higher percentage of House and Senate members if term limits existed. Hmmm…

Onwards!!!