Fundamental Tax Reform is Essential, Inevitable, and Impossible

Twenty-five years ago tomorrow, Ronald Reagan signed the Tax Reform Act of 1986. It was a beautiful fall day and the signing was on the back lawn of the White House. I was there along with many of the other Treasury staff who worked on the historic legislation, as well as a bus load of tourists from Iowa who were hoping for a White House tour, but had to settle for parts as extras in the stagecraft of official Washington. Because I am really tall (6’6”), one tourist asked me to take a picture of the scene, which she couldn’t see through the crowd. I hope it came out.

I loved tax reform.  It lured me away from the sleepy New England college where I was a professor and changed my life. Whether you judge TRA86 a success or a failure, it was a major change to the tax code. It cut top individual income tax rates from 50 to 28% and corporate rates from 46 to 34%. It eliminated a host of loopholes, deductions, and preferences—mostly on the corporate side.  It removed poor people from the income tax rolls.  It taxed capital gains the same as ordinary income, eliminating the single biggest driver of individual income tax shelters and making it possible to slash top tax rates while maintaining the progressivity of the income tax.

And it was fun.  Treasury and Hill staff who worked on tax reform worked incredibly long hours crafting and recrafting provisions as the bill evolved through its many permutations.  It was thrilling.  Even though almost nobody actually thought it would become law, imagining a complete rewrite of the tax code is about as much fun as a tax geek can have.  We were rewriting the Internal Revenue Code of 1954.  Exciting!

But there was little reason for optimism until late in the process. The first version that passed the House wasn’t much of a reform.  Compared with the pristine blueprint that Treasury produced for the President in 1984, the House bill had restored most of the loopholes and didn’t cut rates much. The Congressional leadership didn’t look promising. Ways and Means Chairman Dan Rostenkowski was an old school Chicago pol. (Later, he’d go to jail for mail fraud.) Senate Finance Chairman Bob Packwood used to have weekly meetings with his big donors where they’d tell him about their desires—none of which involved paring loopholes and deductions. (Packwood eventually retired in disgrace after several female staffers recounted his improper advances.) But at some point, these sleazy pols decided that reform was good politics.  Ronald Reagan’s style of benign neglect turned out to be perfect for tax reform.  He’d be AWOL for months, and then show up at a key point to make a great speech or do some arm-twisting. A junior senator from New Jersey, known more for his jump shot than his legislative prowess, turned out to be a master tactician and strategist. Bill Bradley, who later proved to be a lousy politician on the national stage when he ran for president, had unsurpassed skills in the back rooms and ante chambers of Congress.

Somehow, after multiple near-death experiences, the Tax Reform Act passed with overwhelming bipartisan majorities in both Houses of Congress and was signed by the president on that beautiful fall day. I stayed in Washington, made some amazing friends, got to work on Health Reform I at CBO in 1994, returned to the Treasury to head up the office where I’d been a staffer during tax reform, started the Tax Policy Center, and eventually returned to academia to hold a chair in memory of one of my legislative heroes, Pat Moynihan (who was a senior Democrat on Senate Finance during tax reform). I’m pretty sure none of that would have happened without tax reform as I’d never have come to Washington in the first place.  So I have just warm feelings about the Tax Reform Act of 1986.

And it’s easy to get excited about the possibility of a Tax Reform Act of 2014.  Tax reform is even more necessary now than it was in 1986.  Everyone agrees that the tax system is complex, unfair, and inefficient. And it doesn’t come close to raising enough revenue to pay for the government, whose needs will only grow as the baby boomers retire and health care costs continue to rise. There are lots of tax reform plans out there, including the ones produced by theBipartisan Policy Center (my favorite since I helped write it), the Bowles-Simpson panel, and an excellent report commissioned by President Bush.  There’s even an action-forcing event in 2012 when the Bush tax cuts are scheduled to expire. Rather than extending what everyone agrees is a deeply dysfunctional tax code, why not remake it to meet the needs of 21st century America?

Cue the patriotic music.

The only problem is that tax reform is really, really hard and the political process in Washington has eroded far more than the tax code since 1986. Look at the keys to success in 1986. It was bipartisan—a real collaboration, not just two Republicans from New England or two Democrats from the south crossing party lines. In 1986, Republicans and Democrats disagreed as passionately about policy as they do now, but they didn’t hate each other. They could see the possibility of major bipartisan legislation as a win-win.  Now politics is a football game—a zero-sum game where either your team wins or the other team does. Win-win is not possible. (That’s why the parties can continue finger-pointing while inaction keeps millions of Americans unemployed.)

There was presidential leadership.  President Reagan, exalted now as the saint of Republican orthodoxy by his party, was astonishingly ideologically flexible in 1986. His only marching orders were to cut tax rates and keep some kind of tax subsidy for homeownership. Everything else was negotiable. He twisted arms in his own party and worked with Democrats in Congress to make compromise possible.

Could that happen now?  President Obama is probably no more ideological than President Reagan, but he has the problem that the Republicans in Congress hate him.  Maybe if he wins a second term, and preventing his reelection is no longer the GOP priority, collaboration might be possible. But, more likely, the Republicans will be focused on winning seats in the midterm election of 2014 and setting the stage for a White House takeover in 2016. In this era of endless electioneering and political polarization, a bipartisan tax reform bill just seems a wistful dream.

Then there’s the question of what bipartisan tax reform might look like.  The 1986 bill was revenue-neutral and many in Congress are saying that’s what we should do again. There are two problems with that. First, we need revenue.  And, second, revenue-neutral tax reform happened in 1986 only because there was a giant honey pot available to sweeten the blow. TRA86 used a giant corporate tax increase to pay for those big rate cuts for individuals. Since real people don’t think that corporations are people (sorry, Mitt Romney), they were perfectly happy for companies to pay more so individuals would pay less. Most importantly, even corporate CEOs thought this was a good idea. A key point in the 1986 drama was when CEOs came to Washington lobby for tax reform.

This time around, there are no giant corporate loopholes to close. A corporate tax increase is not in the cards.  Revenue-neutral individual income tax reform would inevitably produce many millions of losers, and they’d object strenuously. I just don’t think revenue-neutral reform is politically feasible. And, besides, we need more revenue.

In a more enlightened time, tax reform to help tame the deficit would make a lot of sense. Closing tax expenditures creates the possibility of cutting rates and raising revenue, which could improve economic efficiency (by deterring tax avoidance) and help forestall a debt catastrophe.  But almost all the Republicans in Congress have vowed to never support such an option.

My bottom line:  tax reform has never been more necessary, it’s hard to see a solution to our budget problems without it, and it’s just impossible.

But I’m grumpy because I’ve been home all week with pneumonia. Maybe when I feel better I’ll be more optimistic.

Happy Anniversary.

PS, There’s a fabulous book about the Tax Reform Act of 1986, called Showdown at Gucci Gulch, by Jeff Birnbaum and Alan Murray, who were at the time cub reporters for the Wall Street Journal. It’s really a gripping story, full of drama.

Correction:  An earlier version claimed that Dan Rostenkowski went to jail for embezzling postage stamps, which a reader flagged as incorrect.  Rosty was indicted for stealing postage stamps (and one of my favorite clerks at Ford House Office Building, where I worked in the 1990s, went to jail for her role in the “post office scandal”), but Rostenkowski ultimately pled to only a subset of the 17 counts against him.  According to the New York Times, “with a long prison sentence looming, Mr. Rostenkowski, the veteran power broker, negotiated his last important deal, pleading guilty to two counts of mail fraud. He served 15 months in federal prisons in Minnesota and Wisconsin and finished his sentence by spending two months in a halfway house and paying a $100,000 fine.”  He was never convicted of stealing postage stamps. I stand corrected.

This was originally posted on my Forbes blog.