While lowering income tax rates, an ideal reform would at the same time eliminate special tax rates for capital gains and dividends. These income sources would instead be taxed as ordinary income. The Bipartisan Policy Center recommends equalizing these rates at 28 percent.
If reform is unable to lower the top rate on ordinary income below 30 percent, however, the discrepancy between the top income tax rate and the rate for capital gains and dividends should at least be minimized. Mitigating this differential will establish more equal treatment among taxpayers with different sources of income and dampen the use of tax shelters to convert ordinary income into capital gains.
Now, before everyone reading this laughs at the implausibility of some of these suggestions, a few side notes are needed. It was President Reagan who supported capital gains taxation as ordinary income. He also endorsed ending the state and local deduction in his 1985 tax reform plan, which the Domenici-Rivlin plan would also accomplish.
Twenty-five years later, a serious bipartisan Senate proposal for tax reform, authored by Senators Ron Wyden (D) of Oregon and Judd Gregg (R) of New Hampshire, mirrored many of the proposals presented here, although the Bipartisan Policy Center plan as well as the bipartisan “Simpson-Bowles” plan from 2010 are more far-reaching. Other fundamental reform plans for simplification have been authored over the years in Congress.
These plans have all failed because of special-interest pressure. That’s why, in order to succeed this time, Congress will have to stick to the two main goals I suggested in the beginning: Keep the plan broad enough so that no one gets extraordinary treatment and everyone has to compromise; and make sure the reform has tangible benefits for taxpayers.