What Will the Debt Deal Mean for Tax Reform?

By :: August 2nd, 2011

What will the debt deal mean for the future of tax reform? Sadly, nothing good.

The budget agreement is, for tax reformers, a huge disappointment.  It is based on the fantasy that the nation can return to a sound fiscal footing through spending cuts only.  It entirely ignores the revenue side of the budget. And while a special bipartisan congressional committee representing both the House and Senate (to be called the Gang of 12, I suppose) would have the authority to recommend tax reform later this year, there is no reason to believe it will do so.

Indeed, because the debt deal will limit the ability of Congress to spend money directly, it is likely to encourage lawmakers to expand their use of tax subsidies. Instead of reform, this will only accelerate the trend towards what my Tax Policy Center colleague Gene Steuerle likes to call tax deform.

The new bipartisan deficit committee is set up, in fact, to make it as difficult as possible to fundamentally rewrite the tax code. The panel would be required to find about $1.5 trillion in deficit reduction over 10 years. In theory, it could get the money through either spending or new taxes. But if Congress fails to adopt the panel’s recommendations (assuming it can even agree on a package), the consequence is $1.2 trillion in automatic spending cuts only. Taxes would be exempt from this step.

It is impossible to believe the GOP members of this committee would agree to new revenues. They might support a restructuring that ends some tax preferences and lowers rates but keeps total revenues about where they are (ala the Tax Reform Act of 1986). But the debt deal makes even that difficult. 

Here's why:  The $1.5 trillion deficit reduction target will presumably be measured relative to current law, which assumes the 2001/2003/2010 tax cuts expire at the end of next year. As a result, any changes Congress makes in the Bush/Obama rates would probably be scored by the Congressional Budget Office as a tax cut and only add to the deficit.

As for the Democrats, it is hard to imagine that after the concessions they just made on spending, their panel members would buy into any tax reform unless it reduces the deficit.

A basic rule of tax reform: It will go nowhere if the parties can’t agree on the ground rules. And Rule #1 is lawmakers must determine whether reform should be a revenue-raiser or revenue-neutral. Unless it  can settle that issue (and it can’t), the panel is very likely to simply leave taxes out of its plan entirely.

The other opportunity for near-term tax reform could come with the expiration of the Bush/Obama tax cuts in December, 2012.  President Obama could use that deadline as leverage for reform and, if he laid out a bold plan, might even pull it off.  But such an aggressive step isn’t Obama’s governing style. After all, he blinked when the GOP called his bluff on extending the 2001 and 2003 tax cuts last December. There is no reason to believe he’ll act boldly in the midst of his reelection bid.         

It is very likely that in the end everyone will be disappointed by the debt deal. Republicans will realize it imposes far fewer spending cuts than they think. In truth, it would trim the discretionary budget in 2012 by either $25 billion or $45 billion (depending on what you want to measure it against). While this will mean painful cuts in some programs, it would  reduce total federal spending by only about one percent.  

After next year, all additional non-entitlement cuts would be made at the discretion of future Congresses. And those lawmakers could easily finesse their way out of the triggers and caps in this deal. Past history shows that after just a few years of budget-cutting, Congress (and the public) loses its stomach for painful spending reductions. 

But as disappointed as the GOP will be in the spending reductions, nobody will be as frustrated as the tax reformers. Yet another golden opportunity seems to have slipped through their grasp.

3Comments

  1. Ralph H  ::  10:26 am on August 2nd, 2011:

    I agree with your analysis. The President blew it when he did not act on the Simpson-Bowles recommendation, because his next chance will be in 2012 when the Bush cuts expire. I believe he will then have an all or nothing choice. I just do not see any form of an agreement possible with the current divided government. Tax reform is difficult under any circumstances; nothing was done for the 2 years in 2008-2010.

  2. Michael Bindner  ::  5:03 pm on August 2nd, 2011:

    Comprehensive tax reform is not really a worthy goal when we can get the same revenue gains from gridlock. The only thing that justifies that kind of work would be increasing the child tax credit, both through consolidation of other credits and from savings from ending the mortgage interest and property tax deductions. The only way that is getting done is if Catholic Republicans and Democrats unite to do it under a pro-life agenda.

    The other way to bring tax reform into the committee’s agenda is by using each and every spending cut to authorize an equal amount of permanent change to the tax law. The deal supposedly mandates $2.1 Trillion in spending cuts. If the Committee then specified an equal amount in permanent tax cuts as an offset, tax reform fever may catch on.

    It is probably too early to do much with Medicare and Medicaid, since health care reform could still blow up in everyone’s faces if people begin dropping insurance until they get sick – then use pre-existing condition reform to get coverage in the hospital admissions office. Of course, this would kill private insurance and force a shift to single-payer – in which case Medicare and Medicaid would simply be folded into that program and dealing with their funding issues would be an afterthought.

    If this problem is forecasted early enough, it will likely lead to adoption of a subsidized public option in exchange for repeal of pre-existing condition requirements. Again, paying for Medicare and Medicaid would be an after thought as part of arranging for funding for the subsidy.

    If health care reform survives, eventually clear heads will agree on either letting the Bush Tax Cuts expire, which pay for the Medicare Part B and D and Medicaid deficits nicely. If the will is not there to do that, then premium increases are the natural reform to make these programs more self-sustaining. Of course, premium increases will only fly if the base Social Security benefit is increased, which requires more revenue for Social Security – likely through increasing the payroll tax cap on income. Then the choice can be made on either adjusting the bend points or abandoning them altogether and instead crediting the employer contribution as an average – which would make eliminating the income cap attractive.

    The enactment of a VAT or Net Business Receipts Tax in exchange for taking people off the tax rolls is the ultimate in tax reform – however Obama has no mandate to do this. Such a step should probably be a campaign promise first – which means either some Republican, Democratic challenger or third party contender must propose it in 2012 – or it will have to wait until 2016.

  3. Michael Bindner  ::  5:06 pm on August 2nd, 2011:

    Tax reform has been the Holy Grail of this administration. The only problem is, everyone he appoints to do this for him punts. The Volker Commission punted. Bowles Simpson punted and sadly, no one on the Hill (or outside TPC) seems to be paying any more attention to the Bipartisan Policy Committee than they pay to the Center for Fiscal Equity. Obama has to own tax reform for it to happen – and that won’t happen under this Treasury Secretary. Maybe the next one will be committed to it.