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December 21, 2010

Good Ideas for Vermont Tax Reform

Lower tax rates spread across a larger base are generally a better way to collect taxes than targeting higher rates at a smaller base. This is one of the principles that has been guiding the work of the Vermont Blue Ribbon Tax Structure Commission chartered by the Vermont legislature. The three members of the commission are Bill Sayre, Bill Schubart, and Kathy Hoyt, appointed respectively by Governor Jim Douglas, Speaker Shap Smith, and Senate President Pro Tem Peter Shumlin.

Although the commission has not yet taken a final vote on its recommendations, a majority of the members are reportedly (see Nancy Remsen's story in the Burlington Free Press) leaning towards recommending that Vermont lower its income tax rates and do away with tax deductions. The technical way that this is done is by basing tax rates on adjusted gross income (AGI) rather than taxable income, which is income after deductions. This is not a plan for either increasing or decreasing the amount collected; it is a plan for making taxes both simpler and fairer. IMHO it is also a plan for reducing government intrusion in individual economic decisions – something which should appeal to conservatives of a libertarian bent.

Under one of the scenarios considered by the commission, Vermont's top tax rate could be reduced from 8.95% to 6.96%. Rates for other brackets would be lowered as well; in general, this doesn't change the progressivity of our taxes. The new top rate would be comparable to Connecticut's 6.5% and Rhode Island's 5.99%; both of these states base their taxes on AGI as do all New England States beside Vermont and New York.

Lowering the top or headline rate makes Vermont more competitive even though it may not reduce the amount of taxes a taxpayer in the top bracket actually pays. National surveys of tax rates often leave out whether the base is AGI or taxable income so Vermont tax rates look even higher than they actually are compared to other states.

Those who benefit from specific deductions in the tax code are, understandably, opposed to the deductions being eliminated. Realtors, in general, favor a home mortgage deduction. Charities are concerned that their contributions will fall if they are not tax deductible. Accountants benefit from complexity in general. But is it really the role of government to tell us that we ought to buy rather than rent? Why should a donation to a charity escape tax but money spent to support your mother in a nursing home be taxed? Most important, why should government be putting a thumb on the scales of how we spend our own money and redistribute our money by taxing income spent on unfavored activities at a higher rate in order to finance a deduction for favored activities?

Although this proposal is designed to be revenue neutral, it is very possible that it will collect more money with less cost to the taxpayers.

Q. How is that possible?

A. Contortions to earn deductions actually cost taxpayers money even though that money doesn't end up going to government. Obviously, lawyers and accountants have to be paid. In a more subtle example, wealthy people take out bigger mortgages than they need to shelter income through the mortgage income deduction. In effect, they split the tax savings with a bank. If there is no tax incentive for the mortgage, the state and the taxpayer can both end up with more money and the bank gets less. Lower tax rates mean fewer contortions to avoid taxes.

We won't fully have the nirvana of simpler taxes until the federal system is reformed as well. But that's a possibility. The suggestions of the National Deficit Commission go even further in this direction than those of their Vermont counterparts (there are areas where Vermont shouldn't go it alone). Tax reform and simplification is not a partisan issue at either the state or the national level.

Although comments here are always welcome, comments directly to the Vermont Blue Ribbon Commission (follow this link), at least by Vermonters, are likely to be more effective. A schedule of their planned public hearings is here; the January schedule is not posted yet. The commission is also considering sales and property taxes so watch their website (and this blog) for more on those.

Related post:

The Deficit Reduction Draft Proposal is the Stimulus Program We Need!

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