Major tax overhaul is long overdue

THE BENEFIT OF IMPOSING higher taxes on the rich is that they would chip away at the nation’s deficit problem while satiating Americans’ bloodlust for revenge against those believed to have caused the utter despair

of the economic downturn. But a better, more thoughtful, approach to getting this country back on the road to fiscal sanity would be to close loopholes and broaden the tax base.

We’re talking about a major overhaul of the tax system, a real top-to-bottom renovation on a magnitude not seen since the Tax Reform Act of 1986.

Indeed, the overarching goal of any new reform should be to devise a tax code that is simpler, fairer and more conducive to economic growth and stability.

Unfortunately, the tax plan introduced by President Barack Obama two weeks ago, which includes higher taxes on people making more than $1 million a year, falls short of meeting those goals in many respects.

For starters, Mr. Obama’s so-called Buffett Rule, named after ubër-investor Warren E. Buffett, is premised on the notion that most millionaires pay lower tax rates than middle-class Americans.

That simply is not true.

Of the more than 140 million tax returns filed in 2009, 236,883 filers reported adjusted gross incomes above $1 million. Those filers had a combined income of $726.9 billion, or 9.4% of the $7.63 trillion in income earned that year by all Americans. Factoring out the 1,470 millionaire filers that did not pay any federal income tax at all that year, there were 235,413 filers that paid $177.5 billion, or 20.5% of the $865.9 billion in income tax collected in 2009.

Millionaire filers paid an average tax rate of 25% in 2009, compared with 11% for all taxpayers. Those earning less than $200,000 were taxed at an effective rate of no higher than 12%, according to an analysis of the 2009 data by the bipartisan Tax Foundation.

Rather than raise the effective tax rate on the relative few who are doing well, Mr. Obama would be wise to push for more-substantial changes to the tax code.

We are more inclined to support the deficit-reduction proposal put forth last November by the Bipartisan Policy Center. In that proposal, the center called for the creation of just two tax rates, 15% and 27%, and doing away with the current six-rate system that has a top rate of 35%.

It also suggested reducing the corporate tax rate to 27%, from its current 35%.

Of course, big cuts in tax rates require big cuts in expenditures.

For starters, it is time to reconsider the preferential tax treatment given to long-term capital gains. This form of investment income ought to be taxed at a rate slightly higher, say 20%, than the current 15% rate.

Increasing the capital gains rate to 20% should help boost revenue without dampening investors’ willingness to realize their gains.

In terms of loopholes, it is time to pull the plug on the “carried-interest loophole,” which allows wealthy hedge fund managers to have their performance bonuses taxed at the long-term capital gains rate, rather than at the ordinary income rate.

Then there’s the deduction for home mortgage interest. This is another loophole that needs to be closed — or, at least, shrunk. In an effort to support the real estate market’s efforts to get back on its feet, we recommend phasing out this deduction over a 10-year period.

To be sure, there are no easy solutions to revamping the tax system.

But our tax system is needlessly complicated and burdensome. Even worse, it is a maze of special-interest loopholes that make it terribly inefficient and contribute to the nation’s indebtedness.

Quite simply, America’s taxpayers deserve better.