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You keep using that word. I do not think it means what you think it means.  -Inigo Montoya, The Princess Bride

I came across an article on Bloomberg a couple of weeks ago on the tax reform proposal put forth by Charlie Rangel, the Chairman of the House Ways and Means Committee. Rangel described his tax package as “The Mother of All Reforms“, but like Inigo, I don’t believe that anyone in Congress has a firm grasp of the meaning of the word reform.

Rangel’s proposal would kill the Alternative Minimum Tax (AMT), which is a good start. The AMT was a bad idea from the beginning and has only gotten worse as Congress didn’t bother to index the stupid thing for inflation (see more AMT backup here). However, the reform part of the proposal goes down quickly from there.

The proposal would also increase the Child and Earned Income Tax Credits along with the Standard Deduction (which is indexed for inflation). To pay for all of this (at the rate of $800 billion over 10 years) Congress would increase the complexity of the Tax Code by fixing various “loopholes”. Anytime I hear a legislative body say they are fixing “loopholes” I get concerned.

Basically, that’s because loopholes exist because of the complexity of the Tax Code. Congress wants to give a break for Entity A and writes a law. Entities B, C, and D see the break and want it as well. Congress re-writes the law to include them. However, in the inclusion will be all this other stuff that Congress may or may not have intended. 10 years later, some news report highlights the tax break and Congress comes along and writes another law to “fix” the loophole that will no doubt not remove the initial tax break but will simply complicate the lives of all other businesses.

In this case the loophole is the ability of private equity managers to pay capital gains rates rather than regular income rates on their compensation that comes from the earnings of the company. It was intended to reward managers of companies for taking risks, but news reports started building that all these private equity managers were making hundreds of millions of dollars per year and paying only 15% tax, rather than the 35% top rate.

Along with that, Rangel intends to complicate the Code further by limiting itemized deductions on high earners, even though most itemized deductions already have an income limit and each itemized deduction has a different limit. Another possibility according to Bloomberg would be to have a 4% surcharge on “married couples earning more than $200,000 per year”. I don’t understand singling out married couples but I know the surcharge is there so that Congress can claim that they didn’t raise the base tax rate on income.

All of these proposals will have the exact opposite effect of what reform would mean. All of them would add needless complications to the Tax Code. If reform was really on their minds, they would do away with various credits, deductions, and limitations. I still want to see a candidate that would reform the Code by simply taking away all deductions and replacing that with a high standard exemption. Make it a multiple of the poverty level so that everyone under X% of the poverty level doesn’t pay tax. The rates could be lowered drastically and everyone would benefit rather than the current game of winners and losers that Congress plays every time they add a new paragraph to the Tax Code.

I’m still not holding my breath, though.