Debt Commission plan: Everyone gets less, middle class pay more, wealthy pay less, poor come out even.

I’ve taken a look at the plan outline that the National Commission on Fiscal Responsibility and Reform released yesterday.  The final plan will include a lot of details that may change my view of it, but the plan looks to me to be a very subtle shell game that results in smaller government for which the wealthy pay less, the middle class pay more and the poor neither gain nor lose.

The National Commission is proposing to cut federal spending two dollars for every dollar it proposes in new taxes.  In this blog, I want to take a look at the taxation side, because that’s where the shell game is.  Next week, I’ll give a bird’s-eye analysis of the impact of the spending cuts the National Commission proposes and discuss its approach to Social Security funding and benefits.

The Commission proposes that we cut the federal tax rate to 21% and get rid of a bunch of deductions, the most important of which are capital gains, employee healthcare insurance and mortgage interest.  The idea of creating a simpler tax structure with fewer deductions is very attractive, although technically outside the purview of the debt commission.   

Let’s analyze the potential impact of ending these deductions, one at a time:

• Most of the wealthy would gladly pay an additional 6% on capital gains if it means that the tax on most of their income would be cut by a whopping 14%.  So while capital gains tax is up when you sell investment assets, the compensating decrease in the income tax rate (which applies to income, interest and most dividends) probably will leave rich people with more money.
• You don’t pay healthcare insurance based on what you earn. As expensive as health insurance is, the most expensive plan is still not a large amount of money to someone earning more than $250,000 a year, while the cheapest plan is a hardship for someone earning a low wage.  In other words, ending the deduction for healthcare insurance really raises the taxes significantly for those in the middle class and those poor who do not qualify for free healthcare.
• The bulk of the benefits of being able to deduct interest on a mortgage go to the middle class, and they will pay the bulk of the additional taxes if and when this deduction is phased out.  The wealthier someone is, the lower the percent of their wealth is represented by their primary residence, so the less important the income tax deduction is for mortgage interest.  (One should note that if we end the mortgage deduction, the housing market will likely collapse again and interest rates on mortgages will probably decline as well.  I think it’s a good idea to end the deduction, but doing so will roil the U.S. economy over the short-term until we get used to not depending so much on housing to create individual wealth and overall economic growth.)

Thus, the simpler system that the National Commission proposes will probably increase the taxes of the middle class but reduce the taxes of the wealthy, while leaving the taxes of the very poor about the same.  We won’t know if my analysis is true until we see the complete proposal and someone does a line-by-line analysis of who’s paying more or less and by how much.

I wrote this blog yesterday afternoon for posting this morning.  This morning I read Paul Krugman’s opinion piece in the New York Times.   Krugman makes the same point, that the probably cash flow from the tinkering with the tax system proposed by the National Commission on Fiscal Responsibility and Reform will be from the middle class upwards to the wealthy.  Bravo to Krugman for doing the conceptual math.  And yet, my competitive nature tells me that next time I should post my blog as soon as it is written.