Tax Reform 2.0
President Obama announced yesterday that he has asked former Federal Reserve Chairman Paul Volcker to head a new tax reform panel that will make recommendations by December 4th. This is great news. The current tax system is a complicated mess and can’t produce the revenues we will need in the coming years. But there is no reason for Volcker to reinvent the wheel. His panel could start by looking at the work of a bipartisan tax reform panel established by President Bush in 2005. I may be biased, since I served as the staff’s chief economist, but I think we designed a pretty good blueprint.
Unfortunately our report went nowhere, even though it received wide bipartisan praise from both policy experts and the press. I’d suggest you read it, except that our website www.taxreformpanel.gov seems to have disappeared. Our panel, chaired by former senator Connie Mack (and vice-chaired by former senator John Breaux), heard from more than 100 witnesses, from Nobel Prize winning economists Milton Friedman and James Heckman to mayors, governors, former Treasury officials, tax practitioners, leading policy experts (including many of my colleagues from TPC) and ordinary taxpayers. Until recently, you could have found the report, powerpoint slides of the testimony by the witnesses, and transcripts of the hearings on the Web. TPC has posted the report, but we don’t have the supporting materials.
But ours was a much broader mandate than the Volcker panel has. We took a broad view of reform, and even looked at introducing a value added tax and replacing the income tax with a retail sales tax. In the end, we proposed two rather dramatic plans to redesign the income tax. We did have constraints, since President Bush limited us to revenue-neutral options that would simplify the code, distribute the tax burden progressively, recognize the importance of homeownership and charity, and promote long-run economic growth and job creation.
Those limitations didn’t make our job easy, but we were less constrained than Volcker apparently will be. President Obama has said that no one making less than $250,000 could pay higher taxes under any new reform. That means ninety-five percent of taxpayers can’t pay additional tax, even if it would result in a more efficient system, decrease inequities, or make their lives much simpler. At a time of monster deficits, that pretty much rules out any sensible reforms.
In addition, he appears to be asking the panel to focus largely on ways to close the tax gap—that is, taxes owed under the current system but not paid. Politicians and the IRS have talked about the $300 billion pot of gold for years, but no one has been willing to make the tough choices and more intrusive measures needed to bridge the gap through tougher compliance, more audits, and more collection of information. Raising serious revenue will inevitably involve some hard choices. Fundamental tax reform may be the only realistic avenue to collect a higher proportion of taxes owed.
The 2005 panel did make some hard choices, but ones that would have provided real benefits. For example, we already addressed one of the key areas identified for reform by the Volcker panel: simplification of family and work credits. We proposed a new family and work credit to replace the cumbersome hodgepodge of work and family subsidies in the code now. We also eliminated the Alternative Minimum Tax and kept rates no higher than they are today. To do that, we eliminated numerous individual and business tax preferences. Among other changes, the mortgage deduction was capped and converted to a credit, employer provided health benefits above a cap were taxed, and the state and local tax deduction were removed along with other itemized deductions. Such tough choices are necessary to produce a stable, fair, and efficient tax system.
President Obama would likely make different choices, but our simplified income tax plan would be a great starting point. In future blogs, I plan to highlight some of the ideas put forward by our panel. I hope Volcker & friends will keep our report in mind. To start, they could turn the website, www.taxreformpanel.gov, back on.