Tax Reform: The Wheels Are Beginning to Turn

By :: February 18th, 2011

A recent column in the Christian Science Monitor (first appeared here):

America's tax system is broken. It's needlessly complex, economically harmful, and often unfair. It fails at its most basic task, raising enough money to pay government's bills.

Because of Washington's love affair with temporary tax cuts, it's also increasingly unpredictable. Americans deserve a simpler, fairer, more pro-growth tax system.

It won't be easy. Any reform creates losers as well as winners – and losers always let their representatives know how they feel. But Washington is giving hopeful signs that the journey toward tax reform – the first in a quarter century – may finally be under way.

In his State of the Union message, President Obama called on Congress to reform individual and corporate taxes. He reiterated the offer at a press conference Feb.15. Democrats and Republicans have been holding hearings and drafting legislation. The president's fiscal commission and the Domenici-Rivlin debt-reduction task force (on which I served) have proposed serious reforms, taking hatchets to the trillion-dollar thicket of tax preferences that complicate the code and distort economic activity.

Fixing the corporate tax code looks to be the easier task. Federal and state levies average more than 39 percent, the second highest in the world; we'll take the top spot in April when Japan slashes its rate. Add in rising concern about America's international competitiveness and slow economic recovery, and you have a recipe for a bipartisan push to cut corporate tax rates.

Given America's budget woes, however, we can't afford to reduce future revenues. Unless Washington demonstrates remarkable spending discipline, we will need all our existing revenues, and more, to cover the costs of an aging population and rising health-care costs.

That's where real reform comes in. Along with high corporate tax rates, we also have very generous tax breaks, leaving much corporate income untaxed or facing only low effective rates. Far better would be a system with fewer tax breaks and lower rates across the board.

Such reform would reduce distortions and allow economic fundamentals, not taxes, to guide business decisions. As Mr. Obama put it: "Get rid of the loopholes. Level the playing field. And use the savings to lower the corporate tax rate ... without adding to our deficit."

Congress should pursue the same strategy with an even bigger challenge, the personal income tax. Dozens of exemptions, exclusions, deductions, and credits complicate the code and make Swiss cheese of our tax base. These preferences mean that trillions of dollars of income go untaxed. As a result, Congress must impose higher rates on the income that does get taxed, weakening economic growth and treating unfairly tax-payers who don't milk every preference.

Policymakers should cut those tax preferences, use some of the resulting revenue to cut tax rates, and use the remainder for deficit reduction. A good starting point would be the fiscal commission's proposal to eliminate many tax preferences and use the savings to deep-six the hated alternative minimum tax, cut tax rates across the board, and boost revenues by $80 billion a year. That plan would also make taxes more progressive while retaining slimmed-down deductions for mortgage interest, retirement savings, and charitable giving.

Tax reform will be a journey. The landmark reform in 1986 capped several years of effort. The same is likely to be true this time. If our leaders want to enact the landmark tax reform of 2013, they need to start sharpening their hatchets now.

10Comments

  1. Michael Bindner  ::  10:33 pm on February 18th, 2011:

    The biggest exclusions in Corporate Income Taxes are the fact that only corporations pay them, while other firms pay them as part of personal income taxes, and the fact that labor is not taxed.

    If labor were taxed in business revenue taxes (Larry Linsey’s term) rather than personal taxes the base would be a lot broader and the rates could potentially be a bit lower, although not too much lower if we want to pay for health care in the long term. Any revenue increases should happen slowly, in time with needed spending, rather than collecting too much right away to build a trust fund – as this eventually requires higher income tax collections to repay the fund.

    An income surtax should still be charged on the highest incomes to avoid undertaxing the rich and overtaxing the nonrich and to avoid requiring that high income individuals share all of their financial information with their employers and business interests. For their own confidentiality, it is better that the government act as the information clearing house, rather than any one business entity. Any such surtax should be earmarked to the payment of interest and repayment of debt, rather than using a more general levy for these purposes. Theoretically, if wealthier taxpayers were to transfer some of their investments into “tax futures” bonds that simply expire in a future tax year, then the national debt could be paid off fairly quickly – provided the Federal Reserve was willing to find another set of assets to back the currency – such as mortgage backed securities (marked to market).

    Social Security reform also enters this equation – both because the income cap needs to be increased and because there is a desire to make the program more progessive. While some have floated the idea of making the bend points even harsher than they are, a better alternative is to begin crediting the employer contribution equally (as in, without regard to the amount of the employee contribution). This moves redistribution to the front end and makes the development of personal accounts possible. The more liberal of us could even see doubling the employer contribution and dispensing with the employee contribution entirely – adjusting gross but not net wages in the process. Gross wages would also take a hit with the aforementioned business revenue tax reform, although net wages would go up to compensate for any VAT component to business revenue taxes – with VAT’s being visibile and BRT’s staying hidden.

    As to the composition of personal retirement accounts – they should hold employer voting stock rather than traded equities or corporate or government bonds. This would allow a shift in equity ownership to workers from the wealthy, government bond ownership from retirement funds and the Federal reserve to the wealthy and private and mortgage bonds from the government and retirment funds to the Fed. Indeed, the only non-employee holders of equities would be a fund holding shares in a third of every firms fund to act as insurance and leverage to back employee groups who claim mismanagement. Such a fund could investigate and join 1/4th of employee stock holdings in controlling any company in order to avoid bankruptcy. It could be either private or held by the Federal Reserve System (if needed to back the currency).

    Somehow, I don’t think this Administration or this Congress will go quite that far – even if they adopt comprehensive tax reform. If populists on the left and the right form a coalition like they did on the second engine for the F-35, however, the main features of this plan could very well see the light of serious debate. It would be nice if the TPC would score them, by the way. They are in more detail in my submission to the Fiscal Commission, which was copied to TPC but never commented upon – since TPC was working for Domenici Rivlin rather than scoring the options before the Fiscal Commission.

    I can forward them to you if you wish to make up for lost time, including a model that allocates spending to various taxes.

  2. James Baird  ::  12:55 pm on February 19th, 2011:

    Why on earth would you still be talking about rebuilding the federal income tax code when the solution has already been introduced in Congress – The FairTax Act of 2011 (H.R.25 / S.13)? Is it even possible that you don’t already know about the FairTax? (www.FairTax.org) Or is it (more likely) that you have no desire to see the problems solved because you make your living off the perpetual problems of the current system and the never-ending debates over the next rounds of manipulating it?

  3. Sherwood MacRae  ::  1:23 pm on February 19th, 2011:

    I have to agree – in part, with Jim Baird’s comments about the fact that there is a proposal before Congress that has many of the answers others seem to be seeking, but as he suggests, no one wants to listen/act because they have no reason to take this thorn from the side of the American public.

    I am new to these pages – perhaps you have discussed FAIR TAX earlier and if you have, I – for one, would like to read what you have had to say. AND, if you have not, go to the web-site Jim provided and let your readers know of your opinions.

    That is how we are going to resolve the most critical issue before all Americans, honest and forthright debates.

    Hope to hear more from you – soon!

  4. Michael Bindner  ::  6:40 pm on February 19th, 2011:

    Mostly because Neill Boortz and his supporters misunderstand the logic behind when government services are taxed and when they are not. Their numbers don’t add up – UNLESS – the intention is a 30% drop in budget authority across the board. Revenue neutrality is not enough – you must have expenditure neutrality to pass the tax – which means the 30% rate is inadequate.

    It is also logically inconsistent to want to do both the fair tax and personal accounts in Social Security – unless you want the government to manage those accounts.

    The other reason the Fair Tax is a nonstarter is that the wealthy are more likely to save much of their income, keeping it off limits to the tax. In order to make sure everyone has the same opportunity to accumulate savings and investments, there must be a progressive component.

    Finally, a Fair Tax, as opposed to a Business Revenue Tax, does not have room to use tax expenditures to replace government services with alternatives as chosen by the taxpayer. If you want the government to dispense all social services, you will love the Fair Tax.

    Of course, the Fair Tax is as much a religion as a proposal. Its supporters usually brook no argument, as when the Bush Tax Reform Tax Task Force challenged its numbers. The Task Force was not incorrect in its analysis.

  5. Michael Bindner  ::  6:41 pm on February 19th, 2011:

    See my comments below Jim’s. The Fair Tax as is won’t work. Now, if you don’t attempt to use it as a single tax, I am all for it.

  6. Sid F.  ::  9:01 pm on February 19th, 2011:

    With respect to the Fair Tax, I think the name says it all. The fact that supporters have to call their National Sales Tax proposal the Fair Tax almost certainly means that it is not a fair tax, much like opponents of the Estate Tax have to call it a Death Tax which it is not, and like Fox News must call themselves Fair and Balanced to try to hide the fact that they are Unfair and Unbalanced (and unbalanced in more ways than one). If the Fair Tax were really a fair tax, others would give it that name; giving it to yourself really defeats the purpose.

    With respect to the other proposals, the proponents seem to live in an alternative universe, and while their proposals might make sense and be viable proposals in that universe, they are not so in this one.

    Economists tend to look at taxes and spending as elements of fiscal policy; tax analysts look at the tax system as an exercise in designing an appropriate method to raise revenues for government operations. The general public and the Congress, which has control over spending and taxes does not look at things that way. Instead they look at Federal spending and Federal taxes as a social/economic/political issue. Specifically, the question is how much of National Income should be allocated to the public (Federal) sector.

    Radical Conservatives (and I call them Radical not in a perjorative manner, but because their policy is a radical departure from the current status quo) beleive that the Federal Government should tax and spend at about 14-15% of GDP. They see no role for the Federal Government in Energy, Health, Education, Environmental Protection, Agriculture and they see Medicare, Social Security and Medicaid as private programs. Their Federal government has Justice and the Courts, National Defense, Treasury and Foreign Affairs, about the same role as the Feds had in 1789.

    They want a balanced budget, but at the 14-15% of GDP level. On the revenue side they are there. In fact, were the economic recovery to raise taxes to the 16-18% of GDP level they would be leading the charge for further tax reduction. Their policy goals at this point in time are to balance the budget by reducing spending to that level. This is not a hidden agenda, it is not a secret agenda, in fact you cannot shut them up about it, they talk about it all the time. The problem is many people are not listening, because maybe the message does not penetrate the alternative universe that they live in.

    In the real world Radical Conservatives are in control of the Congress, which is the power source for spending and taxes. The reason that in a previous post the author could not see where the revenues were coming from to reduce the deficit is that the revenues are not coming and are not going to be coming. In the real world there is no Republican Congressman who will vote to raise taxes. Did anyone not notice that two months ago the vote was to substantially reduce taxes? While it is not zero probability that tax increases on any group will take place before November 2012, it is close enough to zero so that you can use zero as the number and not be wrong.

    Furthermore, as I have posted earlier, the liklihood is that Radical Conservatives will increase their representation in the government. Let me explain a little bit more, since some folks do not seem to have understood the point. In 2013 it is possible, say 45% probability that a Republican will be elected President. If so, that individual will have a Republican House and a Republican Senate. Does anyone think the various tax increase proposals presented here and elsewhere will come to fruition? In such a scenario can one imagine abolition of say, the Departments of Education and Energy? Actually, it is difficult if not impossible to not imagine it.

    However, it is more likely at this time that Obama is re-elected, in which case the prospects are even worse for continuing the role of government as is. The reason for this is the fact that since the end of World War II, the party that controls the Presidency has been a disaster for that party in the Congress. When Truman ascended to the Presidency, Republicans took over Congress, and when Eisenhower, a very popular Republican took over, Democrats won big Congressional majorities. Johnson won a landslide in 1964, and Republicans won big in the Congress in 1966 and Nixon won in 1968. In 1974 Nixon/Ford presided over huge Congressional losses for the Republicans, and in 1980 Carter went down and took the Senate Democrats with him. In 1986 a popular Ronald Reagan compaigned hard for Republican Senate candidates, and lost the Senate. Clinton’s huge Congressional defeat in 1994, and Bush’s in 2006 and 2008 are well known. Finally Obama in 2010 presided over a Democratic defeat so large that its scope is still not understood by many, including some who post to this site. The Democratic Party is today no longer a national party. It is largely irrelevant or in the process of becoming so in the South, the Mountain States, TN/KY/WVa, and parts of the midwest and farm states.

    So, if Obama is re-elected, then unless history reverses itself Republicans can gain a huge Congressional victory in 2012 and 2014. Can one imagine 2017 with a Radical Conservative Republican President with 60 Republican Senators and 300 Republican House members? Easily. Can one imagine Democratic control of both Houses of Congress? Well, yes, but only after imbibing legal alcoholic beverages for several days.

    What can defeat this scenario. If Radical Conservative over-reach, so that the majority of citizen see what they actually propose then they may well rise up and change historical trends and set the stage for enacting revenue proposals. What does anyone think the probability of that scenario happening is today?

  7. Michael Bindner  ::  8:22 am on February 20th, 2011:

    The demographics don’t favor continued GOP hegemony. To put it indelicately, much of the Tea Party will die off before that happens.

    Additionally, because their commitment to spending cuts exists in an alternative universe, they likely won’t happen. Even if they do abolish the Dept. of Energy – if Obama doesn’t beat them to the punch – the regional power authorities will still exist in some other agency, as will the oil and gas bureau and the nuclear administration.

    They are all about symbolism. Reality is messier.

  8. Sid F.  ::  9:00 am on February 20th, 2011:

    Those who believe that demographics will work against Conservatives need to look at Texas. The just released Census report showed that there was huge growth in the Hispanic population in the state in that last decade. This must have resulted in huge gains for the Democrats statewide in Texas. In fact, statewide the Democrats suffered a tremendous defeat. The open Senate seat in that state will be decided in the Republican primary.

    Here is today’s story about Louisiana

    “ABBEVILLE, La. — A Republican candidate late Saturday won a special election for a Louisiana state Senate seat, according to unofficial returns, a result that if certified would give the GOP control of the Senate for the first time since Reconstruction”

    Waiting for demographics to rescue a Democratic Party whose only strategy is to hope for over-reach by Radical Conservatives and that in all respects is lacking in leadership and organization is like waitng for Godot.

  9. nikos  ::  10:50 am on February 20th, 2011:

    politicians are blinde!! they dont see that all people suffer..

  10. Michael Bindner  ::  12:27 am on February 21st, 2011:

    that was about turnout, possibly with voter intimidation. It won’t last.