Fundamental Tax Reform is Essential, Inevitable, and Impossible

By :: October 21st, 2011

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.

10Comments

  1. Michael Bindner  ::  12:55 pm on October 21st, 2011:

    Bruce Bartlett has a good book coming out on the prospects of tax reform. I won’t spoil the punch line, but I agree with his prognosis unless the Joint Select Committee, who are surrogates for leadership, come to a deal – not in the fall, but after the GOP Senate Primary in Kentucky. If the Tea Party either beats or is defeated by the Senate Republican Leader, he has nothing to lose – which frees Boehner to deal too, since he has the votes if he compromises with his miniority leader and throws the Tea Party under the bus. There is adequate consensus on budget cuts and tax raises for a $4 Trillion Deal and some of those will look like comprehensive reform. While the BPC reform, the Graetz Reform, the Linsey Net Business Receipts Tax, the Bush Reform (VAT version) or the reform by the Center for Fiscal Equity would be equally agreeable – although I do like mine best – I suspect too much ink has been dedicated to opposing a VAT of any kind to have any choice but the Fiscal Commission version. The alternative is letting the Bush/Obama cuts expire, in whole or in part (another good alternative if the Republicans agree to match the 2.4 in likely budget cuts with tax cut offsets favored by Obama), but that can only happen if the economy is doing better than the 1.5 to 2% range people expect. The other alternative is yet another extension, but only if Obama gets something for it.

  2. Becky Hargrove  ::  4:02 pm on October 21st, 2011:

    Get well soon! I like the story about how much fun it was to close all those loopholes. If only Washington understood that people would feel a lot better, if those in government did not dislike each other so.

  3. Len Burman  ::  4:35 pm on October 21st, 2011:

    Becky, Thanks.

  4. Happy Anniversary, Tax Reform « Donald Marron  ::  10:59 am on October 22nd, 2011:

    […] at the Tax Policy Center, Len Burman and Gene Steuerle, both Treasury staffers at the time, and Howard Gleckman, who covered the […]

  5. How Are You Celebrating? | Times & Seasons  ::  3:46 pm on October 22nd, 2011:

    […] articles around the web summarizing what the Act meant and how it came through. You could read this article for a taste of the process. Or you could read any or all of these articles, if you’re […]

  6. Ralph H  ::  3:03 pm on October 23rd, 2011:

    Unfortunately your conclusions are correct.

    The public wants tax reform, particularly if it does away with prefferential treatment of individuals and corporations. This is the reason why the 9-9-9 and Flat Tax gain traction. Take the 9-9-9.

    On personal return we would gain greatly, even though we would lose a big deduction for homes. I am not clear how the business’ would fare, but I believe we also would save, mainly because not paying FICA and Medicare. For new sales tax we pay more than 50% for mortgage and retirement savings, so our rate would be 9% on perhaps 40% of income; so net sales tax is under 4%.

    Compare to present system. Our present FICA, Medicare and Federal tax is 25%, and my company’s tax is 7.5% on Labor and effective 26% on Profit, which (depending on how we fare) is harder to predict than the 9% business portion. With something like the 9-9-9 it is easier for an individual company to add or subtract a percentage to the selling price, because it would not vary.

    My point is that a straightforward new tax will be easier to plan for, and would add certainty. As a side note I believe that tax policy center has miss-estimated the effect of the sales tax and the company tax to the high side. When figuring taxable sales you must deduct 9% tax, mortgage, savings, and used goods purchased.

  7. Webcomm  ::  1:51 pm on October 24th, 2011:

    Bruce Bartlett has a good book!

  8. steve  ::  10:17 pm on October 24th, 2011:

    Too bad he didn’t sign an executive order declaring property taxes unconstitutional.
    Hey, maybe our current leaders will consider this option.
    The american dream of property ownership has always been a farce.

  9. VATfan  ::  7:41 am on October 25th, 2011:

    Sadly, you are right…sweeping tax reform is virtually impossible with too many politicians (and lobbyists) lined up in opposition. Unfortunately, too, it is not optimism that will fuel tax reform at this time.

    However, with an economy that is not structured for success in this era of globalization…with outsourcing continuing to eat away at domestic employment, a change is truly needed. We should replace the Corporate Income Tax with a Value Added Tax. This replacement would eliminate a competitive disadvantage in world trade, since all our trading partners and over 150 countries use the VAT to eliminate a tax burden of government from the price/value comparison of exports and imports. It would make the U.S. – without a CIT – a magnet for foreign investment and would incent U.S. multi-nationals to bring capital and profits home.

    As Gov. Mitch Daniels, who served as head of OMB has endorsed, we could also look to balance the VAT with a flat Personal Income Tax with a high threshold that would provide some progressivity. The lower quintiles could be protected from the VAT through the EITC. (Daniels video: http://wp.me/p18NCA-9n )

  10. Economic Scene: A Nation With Too Many Tax Breaks — Economic Scene | Stop News Daily  ::  10:35 am on March 14th, 2012:

    […] of 1986, overcoming absolute opposition. Those in a trenches during a time remember it as an epic struggle. But for all a heroics, taxation expenditures were pared usually to 6 percent of sum domestic […]