Op-Ed: The Baucus-Hatch “Blank Slate” Approach to Tax Reform Could Be Revolutionary

The Government We Deserve | July 3, 2013

No one quite knows what exactly Senate Finance Committee Chairman Max Baucus (D-MT) and Ranking Member Orrin Hatch (R-UT) mean when they say they will rely upon a “blank slate” as the starting point for tax reform discussions. But done carefully and with political artistry, taking advantage of their unique power, Baucus and Hatch could revolutionize how members of Congress negotiate the future of taxes.

But it’s all in the practice, not the theory. Done right, the strategy could reenergize the tax reform debate. Done wrong, it will be just another dead-end.

The idea of reforming the tax system from a “zero base” or building up from a blank slate is hardly new. And lawmakers always talk about everything being on the table. The challenge is in making it happen.

Baucus and Hatch must accomplish two goals. First, they must shift the burden of proof from those who favor reform to those who would retain the status quo. Second, they must force members to pay for their favored subsidy, denying them the opportunity to pretend it is free.

As a veteran of the Tax Reform Act of 1986, I always emphasize the crucial role of process. Sure, serendipity smiles or frowns unexpectedly on any endeavor, but the ’86 effort took off when Treasury, President Reagan, House Ways & Means Chair Dan Rostenkowski (D-IL), and Finance Committee chair Bob Packwood (R-OR) all put forward proposals that started with specific rate cuts and removal of many tax preferences.

Their plans were all somewhat different, but each changed the burden of proof. Lobbyists won many later battles, but now they were forced to explain why they needed to retain special preferences when others would not be so favored. Moreover, given a fixed revenue target, restored preferences had to be paid for. Lawmakers had to acknowledge that the price of adding back tax preferences was a higher tax rate.

Baucus, ideally with the support of Hatch, can put forward a “chairman’s mark” from which committee members can debate amendments. As both senators have suggested, that mark can be a relatively clean slate. Further, Baucus can require that amendments must not add to the deficit or change his revenue target, effectively requiring members to offer what are called “pay-fors.”

Normally, members debate items one at a time. Each adds a new subsidy without worrying about who pays for it—perhaps those currently too young to vote or the yet-unborn.

In dark times, politicians try to reduce the deficit by figuring out what tax increases or spending cuts will restore order to the budget. But identifying losers is immensely unpopular among voters, and politicians shy away from it. Worse, they blast those from the other party brave enough to provide details.

But if Baucus sets a revenue target at the beginning of this tax reform exercise, the dynamic shifts—from simply identifying winners and losers to explicit trade-offs. Winners and losers march together. With a blank slate or zero base, every restoration of a tax break requires higher rates (even an alternative tax), especially if there are few or no alternative preferences to sacrifice.

This process not only gives new life to a broad rewrite of the tax code but also makes it much easier to reform specific provisions. For instance, tax subsidies for homeownership, charity, and education can be much more effective and provide more bang per buck out of each dollar of federal subsidy. But politicians largely ignore such ideas because they create losers who scream loudly. Thus, the default for elected officials who fear negative advertising and loss of campaign contributions is to do nothing to improve these tax subsidies.

But when the burden of proof changes, a lobbyist can appear to be helping his masters simply by saving a subsidy, even if the net benefit is smaller than in the old law. After all, preserving a preference in some form is success relative to a zero baseline. Of course, as we learned in 1986, this argument grows stronger as the probability of tax reform grows.   Can Baucus and Hatch change the burden of proof and force members to pay with higher rates for the subsidies they want to keep? They can certainly lead their committee and Congress in that direction, but only by specifying precisely a chairman’s mark that sets revenue and rates while slashing tax preferences.

If they do, Baucus and Hatch may force fellow senators to acknowledge that every subsidy must be paid for. And that, in turn, will open a window to design alternative tax subsidies that are fairer and more efficient. This sort of process revolution could remake policy in ways that extend well beyond tax reform.

Op-Ed: The Myriad Benefits of a Carbon Tax

The New York Times | June 28, 2013

Few goals in Washington have more bipartisan support, at least in theory, than cleaning up the tax code. Republicans and Democrats say they want a system that is simpler, fairer and more efficient. Put simply, they want a system with fewer special tax breaks and lower rates.

Yet one of the best ideas for advancing all of those goals – and also heading off catastrophic climate change — isn’t even on the table. I refer to a carbon tax, which would impose a price on emissions of carbon dioxide and other greenhouse gases.

Most climate experts concur that dangerous climate change is occurring at a more rapid rate than expected. They also agree that the deterioration in the earth’s climate is primarily a result of carbon emissions from fossil fuel consumption by humans. If you dispute the overwhelming scientific consensus about man-made climate change and the role of fossil fuel emissions, you should probably stop reading now. Evidence is unlikely to affect your opinions.

But if you accept this consensus, you should know that economists across the political spectrum agree that a carbon tax is the most effective way to discourage carbon consumption and lower the risks of catastrophic climate changes.

I am convinced by the environmental case for a carbon tax. But I want to make a broader argument: a carbon tax could be an engine for tax simplification, deficit reduction, less government regulation and even increased competitiveness.

To be sure, the environmental urgency alone is compelling. In May, atmospheric concentrations of carbon dioxide reached nearly 400 parts per million. When concentrations were last that high – more than three million years ago — humans had not yet appeared, the world was warmer by 3 to 4 degrees Celsius, and sea levels were 80 feet above where they are today.

United Nations negotiators have set a limit of 450 parts per million to prevent costly and irreversible changes in the earth’s climate. At current emission trends, the world will cross this limit in a matter of decades.

The anecdotal evidence of climate change is everywhere: melting Arctic ice, new migration patterns for plants and animals and extreme weather events including record droughts, heat waves, epic floods and super storms. The frequency, intensity and costs of such events are increasing at an alarming rate. Climate scientists have moved from the view that such events are consistent with climate change to the view that climate change significantly increases the odds of their occurrence.

Economists have long contended that a carbon tax is the most effective and simplest way to reduce carbon emissions. Conservative supporters include Gregory Mankiw, a former economic adviser to President George W. Bush, and George P. Shultz, who was secretary of state under President Reagan. Economic centrists include Alan Blinder of Princeton and Robert Frank of Cornell University. Further to the left are the Nobel laureate Joseph Stiglitz and Robert Reich, former secretary of labor. James Hansen, NASA’s former top climate scientist, is also a vocal champion of carbon taxes. So is former Vice President Al Gore, who has advocated carbon taxes for the last 35 years as the policy most likely to be successful in combating carbon emissions.

The beauty of a carbon tax is its market-based simplicity. Economists since Adam Smith have insisted that prices are by far the most efficient way to guide the decisions of producers and consumers. Carbon emissions have an “unpriced” societal cost in terms of their deleterious effects on the earth’s climate. A tax on carbon would reflect these costs and send a powerful price signal that would discourage carbon emissions.

Producers and consumers would adjust their behavior in response to this signal in ways that are most efficient for them. And these efficient micro decisions would support efficient societal outcomes.

There’s much debate about what the proper “social cost of carbon” might be, but there is no debate that carbon emissions are seriously underpriced. Any tax on carbon would be an important step in the right direction, and it could be gradually increased to give consumers and producers time to modify their decisions.

Without a tax, the government has to rely on second-best regulations to limit carbon emissions. Facing Congressional inaction and staunch opposition to a carbon tax, this week President Obama proposed regulations on carbon pollution standards for new and existing power plants using his executive authority under the Clean Air Act.

A carbon tax is also a cheaper and often more efficient way to reduce carbon emissions than subsidies for alternative fuels. Generous subsidies for biofuels have cost billions of dollars; by reducing the price of gasoline they may have perversely increased rather than decreased carbon emissions.

Other subsidies, like the production tax credit, have been successful at ramping up research, development and deployment of alternative energy technologies in recent years. Such subsidies would be even more effective in combination with a carbon tax that would make fossil fuels less price-competitive and would stimulate research on renewable and energy-saving technologies.

The Congressional Budget Office estimates that even a modest carbon tax could reduce both greenhouse emissions and the federal budget deficit. A tax of $20 per ton of carbon dioxide, which would translate to about 15 cents per gallon of gasoline, would reduce emissions by 8 percent and generate up to $1.2 trillion in tax revenues over 10 years.

None of this is controversial to economists. As Professor Mankiw remarked a few years ago, the basic argument for a carbon tax “is so straightforward as to be obvious.”

Politically, of course, it’s anything but obvious. Republicans and Democrats fear that a carbon tax would antagonize voters by raising the prices of products with fossil fuel content for everyone who uses them. Republicans worry that a carbon tax would be a source of government revenue to feed “big government spending.” Democrats worry that a carbon tax would be regressive.

Both objections are easy to address. The revenues from a carbon tax do not have to be used for more government spending; the tax’s burden on low-income families can be offset by targeted income support measures, like those used in other countries to offset the regressive effects of value-added taxes.

Adele Morris at the Brookings Institution estimates that diverting just 15 percent of the revenues from a $16-per-ton carbon tax would provide enough money to keep low-income households whole. The remaining money could be used to finance a substantial reduction in corporate tax rates and reduce deficits by $815 billion over 20 years. Government spending would not increase.

Put another way, a carbon tax can be a central pillar of tax reform and sound fiscal policy. If a carbon tax were used in part to replace other forms of taxation, it would be a major force for tax simplification. It may seem like a “liberal” initiative, because its core purpose is to slow climate change. But a carbon tax also bears a strong resemblance to the kind of flat, broad-based tax on consumption favored by many conservatives.

Opponents of a carbon tax, and of climate-change legislation in general, often assert that it would put the United States at a competitive disadvantage. They usually point to China, the world’s biggest emitter of greenhouse gases (the United States is in second place and not far behind).

The competitiveness objection to a carbon tax is crumbling fast, however. This year, China announced plans for a carbon tax. Many European countries with which the United States competes, including Germany, an export powerhouse, already have carbon taxes in addition to very high gasoline taxes.

In May, the World Bank reported that countries that either have carbon taxes or are scheduled to impose them account for 21 percent of global greenhouse emissions. If you add China, Brazil and other countries that are actively considering carbon taxes, the share goes up to more than 50 percent.

In his speech, President Obama said the United States must lead international efforts to combat climate change, calling for a global free trade in environmental goods and services and renewed negotiations on a global agreement to reduce carbon. The United States could breathe new life into these negotiations by announcing its commitment to a carbon tax harmonized with those of other nations.

A well-designed carbon tax is probably the single best tool for fighting catastrophic climate change and safeguarding the earth for future generations. It can also be a key component of tax reform and deficit reduction, both of which would enhance the nation’s competitiveness. Much of the world is already heading for a carbon tax: the United States should get out in front and lead the way. As Mr. Gore recently blogged, “A tax on carbon is an idea whose time has come.”

Op-Ed: Modernizing Corporate Taxation

Project Syndicate | June 26, 2013

How to tax the income of multinational corporations (MNCs) was an unlikely headline topic at the recent G-8 summit in Ireland. It will be a key agenda item at the upcoming G-20 summit in Russia as well. Given these companies’ significance to national and global economic performance, world leaders’ focus on the arcane intricacies of corporate taxation is easy to understand – perhaps nowhere more so than in the United States.

As the US embarks on the difficult path of corporate tax reform, it should heed the United Kingdom’s example. Even as it champions multilateral cooperation to ensure that MNCs pay their “fair” share, the British government has slashed its corporate rate, exempted the active foreign income of British MNCs from the national corporate tax, and enacted a “patent box” that stipulates a 10% tax rate on qualified patent income.

As a result of years of cuts in corporate tax rates by other countries, the US now has the highest rate among the advanced economies. Reducing the top US federal rate, currently at 35%, to a more competitive level – the OECD average is around 25% – would encourage investment and job creation in the US by both domestic and foreign MNCs.

Paying for a rate cut by eliminating various corporate credits and deductions would simplify the code and trim the cost of compliance. It would also enhance efficiency by curbing tax-based distortions in companies’ investment decisions (what and where) and their choices concerning how to finance investments and which organizational forms to adopt. The Obama administration and Congressional leaders from both parties agree that a cut in the corporate tax rate should be revenue-neutral.

Other advanced industrial countries have paid for corporate rate reductions partly by restricting depreciation and other deductions. Despite lower tax rates, corporate tax revenues have not declined in these countries and represent a larger share of GDP than they do in the US.

In addition to reducing its corporate tax rate, the US needs to reform the way it taxes its MNCs’ foreign earnings. All other G-8 countries (and most OECD countries) boost their MNCs’ competitiveness by taxing only their domestic income, exempting most of their foreign earnings from domestic taxation (an approach known as a territorial system). The US, by contrast, taxes its MNCs’ worldwide income, with taxes paid elsewhere credited against their US tax liability to avoid double taxation.

The worldwide system puts US-based MNCs at a competitive disadvantage. They must pay the high US corporate rate on profits earned by their affiliates in low-tax foreign locations, while foreign MNCs headquartered in territorial systems pay only the local tax rate on such profits.

Current US law blunts this disadvantage by allowing US companies to defer paying US tax on profits earned abroad by foreign affiliates until they are repatriated to their US owners. As a consequence of both the high US tax rate and deferral, US-based MNCs have a strong incentive to keep their foreign earnings abroad. Indeed, their non-US affiliates currently hold an estimated $2 trillion in accumulated foreign earnings.

These earnings are “locked out” and unavailable to finance investment and job creation in the US, without incurring significant additional US taxes. Moreover, US companies incur efficiency costs from the suboptimal use of deferred earnings and higher levels of debt, as well as the burden of maintaining worldwide tax strategies. And these costs, estimated at 1-5% of deferred earnings, have been rising rapidly in recent years, in line with the growing share of foreign markets in US-based MNCs’ revenues.

A territorial system would address the competitiveness disadvantages, the “lock-out” effect, and the inefficiencies of the US’s worldwide approach. But it would not reduce incentives for US corporations to shift their reported profits to low-tax jurisdictions; on the contrary, such incentives would be even stronger in a pure territorial system. Given increasing globalization of business activity; the rising importance of intangible capital that is difficult to price and easy to move (for example, patents and brands); competitive cuts in national corporate tax rates; and the spread of tax havens, income shifting and the resulting tax-base erosion have become a major policy concern throughout the OECD.

In response, other developed economies have used a variety of techniques to create “hybrid” territorial systems aimed at countering tax-base erosion. Such systems include transfer-pricing rules based on OECD guidelines (used by the US as well), limits on interest deductibility, and domestic taxation of some kinds of income earned in low-tax locations where companies report large earnings but carry out little real economic activity.

As part of comprehensive corporate tax reform that includes a revenue-neutral rate cut, the US Congress is currently considering a hybrid territorial reform and evaluating several measures to counter tax-base erosion and income shifting, including those used by other advanced countries. Republican Congressman David Camp, who is leading the legislative effort in the House of Representatives, has proposed an innovative alternative that rests on the “destination principle”: MNCs’ taxable earnings should be based largely on where their products are sold, rather than on where the companies are headquartered, where their production and financing occur, or where their profits are reported.

Camp’s proposal would significantly reduce incentives to move manufacturing abroad for tax reasons. By contrast, both America’s worldwide system and other countries’ hybrid territorial systems rely on an “origin or source principle” that bases taxation largely on where input costs and production activities are located.

The US last reformed its business tax code in 1986, when it had one of the lowest corporate tax rates in the world and the competitive dynamics of the global economy were very different. It is time for another comprehensive corporate tax reform, one that reduces the tax rate, broadens the tax base, and adopts a hybrid territorial approach with effective base-erosion safeguards.

Op-Ed: A Bipartisan Case for Chained CPI

The Hill | May 9, 2013

Over the last few days, politically driven critics have called on the president to abandon his support for changing the way the government indexes provisions in the budget to inflation by switching to “chained CPI.” Looking beyond politics, we’re here to say that these critics’ arguments are wrong on their merits.

As economists from opposite ends of the political spectrum, we would strongly urge the president and leaders in Congress to continue to support moving to chained CPI, which represents the most accurate available measure of inflation and cost-of-living increases. Switching to this more accurate measure of inflation represents the right technical, fiscal and retirement policy — and policymakers should not delay any further in making this improvement.

From a technical sense, the current CPI — or consumer price index — that is used to index many parts of the budget and tax code is widely understood to overstate inflation. This is because it fails to account for so-called “substitution bias,” in which consumers reallocate their purchases depending on the relative prices of similar goods. For example, if the price of apples goes up, consumers will buy more oranges. However, this behavior is not accounted for in standard CPI measurements.

The Bureau of Labor Statistics, which calculates the CPI, is very aware of this shortcoming, which is why it has developed and refined the chained CPI for more than a decade. The nonpartisan Congressional Budget Office states that the chained CPI “provides an unbiased estimate of changes in the cost of living from one month to the next.”

Some argue that using the chained CPI to index Social Security benefits is inappropriate because it does not reflect inflation for retirees, which critics suggest is higher than it is for working-age adults because of the elderly’s higher rate of spending on healthcare. However, the CBO has said that based on the available research, it is unclear whether the cost of living actually grows at a faster rate for the elderly than for younger people, and that the CPI-E  —“E” for “experimental” — which was intended to provide a more accurate measure of inflation for seniors, has several methodological flaws that overstate inflation, including underestimating the rate of improvement in healthcare.

Beyond the technical case for the chained CPI, there is a strong fiscal case. Because current measures currently overstate inflation by about 0.25 percent per year, moving to a more accurate measure would result in real deficit reduction. Measuring inflation more accurately would generate savings from throughout government: about $390 billion in the first decade alone. Roughly one-third of those savings would come from slower growth in Social Security benefits, another third from revenue increases (as certain tax provisions such as the cutoff points of income tax brackets  are indexed to inflation) and the remaining savings from a combination of other spending programs and lower interest payments on the debt. Given the very real need to begin to put our debt on a sustainable path, this would be a small but important contribution. The savings would be gradual, with only a small amount in the near term, thus protecting our fragile recovery from immediate austerity.

Finally, switching to chained CPI is the right retirement policy — or rather, a small piece of it. The Social Security program is on a path to exhaust its trust fund. Current projections indicate that this will occur in 2033, threatening cuts for all beneficiaries, including the very rich and the very poor, the very young and the very old, veterans, disabled workers and others. Improving the way we measure inflation won’t prevent the program’s looming insolvency, but it will eliminate a full fifth of the long-term funding gap.

To the extent that the overpayments under the current formula offset the shortcomings of our current retirement system for the lowest-income and most-elderly beneficiaries, a switch to chained CPI can and should be accompanied by targeted policy changes providing benefit enhancements designed to help the affected populations, rather than providing higher-than-justified inflation adjustments for all beneficiaries.

The federal government should not knowingly continue to measure inflation inaccurately, especially given the costs to the budget and to the Social Security program. Changes that cut Social Security benefits are a tough sell for Democrats, and changes that increase revenue are a tough sell for Republicans. But if they cannot even agree to a technical correction to those areas of the budget, how will they be able to make the hard choices to control our debt and reform our government over the long term?

Op-Ed: Measuring Inflation Right is Both Fair and Accurate

The Hill | April 30, 2013

In his recent blog entry on chained CPI (Chained CPI: Unfair and inaccurate, April 26th), AARP President Robert Romasco highlights his groups opposition to the change, charging that it would be “Unfair and Inaaccurate.” In fact, nothing could be further from the truth.
A coalition of strange bedfellows, including Grover Norquist’s Americans for Tax Reform and, have announced their opposition to this policy, even as many responsible policymakers from both sides of the aisle and at the highest levels of government continue to support it – notably, the president and the Speaker of the House.

It is no surprise that groups from the left and right have mobilized to defend the status quo in order to avoid the tough choices that must accompany any responsible deficit reduction plan. Yet, the resistance to a reform as simple and obvious as using the most accurate measure of inflation for price-indexed provisions in the budget is both astounding and disappointing.
Economists from the left, right, and center are in broad agreement that chained CPI more accurately reflects cost-of-living increases by accounting for the small-sample and substitution biases in the current inflation measure. This view is shared by experts at the non-partisan Congressional Budget Office as well as the experts at Bureau of Labor Statistics who are responsible for measuring inflation. Adopting the chained CPI doesn’t represent a policy change, but rather would best reflect the current intent of the law to index various provisions to inflation.
And while some argue that seniors face faster cost-growth than other populations, there is little evidence of a significant difference when one accounts for the fact that seniors are more likely to own their own homes mortgage free, have different shopping habits than younger populations, are able to take advantage of senior discounts, and receive constantly improving health treatments. Indeed, according to the Congressional Budget Office, “it is unclear, however, whether the cost of living actually grows at a faster rate for the elderly than for younger people.”
Moreover, offering seniors a preferential inflation measure raises more fairness concerns than it answers. If seniors receive a higher inflation measure, should non-seniors on the Social Security program receive a lower measure? Geographic inflation disparities are far larger than alleged age disparities (inflation has averaged 2.7 percent in New York and 1.8 percent in Detroit over the last decade); why protect seniors and not New Yorkers? What about other government programs and tax provisions? Should each be indexed to costs within its population? Or only those backed by powerful interest groups?
Indeed, it would be highly unfair to politicize inflation indexing or to exempt any government program or tax provision from the most accurate available measure of inflation.
More unfair would be ignoring our fiscal and retirement challenges and leaving the job to a future politicians. According to the left-leaning Center on Budget and Policy Priorities, the President’s chained CPI proposal would result in benefit levels 1 to 2 percentage points lower than under current law – and it accompanies the switch with benefit enhancements for the old that actually reduce poverty among that group. By comparison, there is a 25 percent cut scheduled to occur under current law when the trust funds dry up in 2033. The greatest unfairness would be allowing this across-the-board benefit cut to hit every beneficiary regardless of age or income – when this cut could be easily avoided through a balanced package of revenue and benefit adjustments.
Mr. Romasco is right, we need a national conversation on improving retirement security, including how to make Social Security sustainably solvent in order to avoid abrupt benefit cuts and ensure the system is better protecting those who rely on it. Ideally, we’d have this conversation now. However, the overheated reaction to a technical correction in cost of living adjustments suggests that the political system may not be ready to tackle comprehensive Social Security reform. Continuing to index benefits improperly while we wait for this reform to materialize would be a costly mistake that will only make future Social Security changes more painful.

Op-Ed: Tax Reform Can Be the Key to a Debt Deal

The Hill | April 11, 2013

The Senate and House of Representatives both have passed budgets that represent the preferences of the majority party in each chamber. Now it’s time to agree on a plan that can attain support from both parties.

Tax reform can be the key that unlocks the puzzle.

On Wednesday, President Obama released a budget request that offers some entitlement savings in exchange for additional tax revenue.

While many assume that getting an agreement on additional revenue is impossible, reform that cleans up the tax code, makes it more efficient and enhances competitiveness — along with significant structural entitlement reforms — could provide the breakthrough we need for a plan that addresses long-term national debt while promoting economic growth. That is a lot of pressure for an undertaking that is both desperately needed and treacherously complicated.

There is support in both parties for reforming the more than $1 trillion a year in tax deductions, exemptions and other loopholes known as “tax expenditures,” which are essentially spending through the tax code.

Many of these tax expenditures are only enjoyed by select taxpayers and distort the economy by disproportionately benefiting some activities, companies or industries over others. We can both reduce tax rates and the deficit by eliminating, limiting or reforming these loopholes that adversely affect the budget and the economy.

The Simpson-Bowles debt commission illustrated one way to deal with tax expenditures: Its plan outright eliminated most expenditures and reduced tax rates to much lower than they are today.

If lawmakers want to reinstate a tax break, they would have to pay for it by buying the rates back up. I love this approach and would hope lawmakers would have the fortitude to start with a clean slate and limit the number of tax breaks they layered back in. But the political pressure to protect and preserve every single tax break would be mind-boggling.

The home mortgage interest deduction pushes housing prices up, and it subsidizes the lending and building industries. And the healthcare exclusion is a major contributor to escalating healthcare costs. But people love their tax breaks — the industries that benefit love them even more — and there is real cause for concern that the massive lobbying effort to preserve these breaks could derail tax reform entirely.

Another approach designed by myself, Marty Feldstein and Daniel Feenberg of the National Bureau of Economic Research, which would cap tax expenditure benefits at a set level of household income, might be more politically plausible. The advantage of this approach is that it eliminates the haggling over which tax expenditures to keep, which should make this reform easier to enact, given the political realities we face.

The Feldstein-Feenberg-MacGuineas tax expenditure cap represents a straightforward way to limit tax breaks. You basically set the limit that no taxpayer could have more in tax breaks than a percentage of his or her income (we generally assume 2 percent, but this could vary) and then don’t have to pick and choose which of the existing tax breaks to eliminate.

This approach has the potential to raise hundreds of billions or even trillions of dollars over a decade, generating revenues that can be used both to bring tax rates down and reduce the deficit. It meets a general test of fairness that some people should not benefit disproportionately from the tax code as they do now. Additionally, it can be adjusted in several ways to make it more progressive or meet a variety of different tax objectives, such as by altering which tax breaks are included in a cap.

Thankfully, tax reform appears to be moving forward this year. Senate Finance Committee Chairman Max Baucus (D-Mont.) and House Ways and Means Committee Chairman Dave Camp (R-Mich.) have been preparing for over a year to rewrite the tax code. The bipartisan, bicameral duo is committed to fundamental tax reforms and the lawmakers are closely coordinating with each other.

The support and cooperation of the leaders of the congressional tax-writing committees is a positive sign that tax reform can happen.

Agreeing on tax reform that relies on a tax expenditure cap could help pave the way for a comprehensive agreement to alter the unsustainable trajectory of our national debt. Hopefully, such an approach could open the door to a truly bipartisan, comprehensive deal.

Op-Ed: The Tax Code Is A Hopeless, Complex, Economy-Suffocating Mess

Brookings | April 4, 2013

Throughout our population, experts and non-experts alike, the verdict is nearly unanimous. The U.S. tax code is a hopelessly complex mess, antithetical to growth, and is crammed with conflicting incentives, which screams for reform. But there is little agreement on how to repair it. My preferences are necessary, just, and ordained in heaven. Your preferences are unnecessary, unjust and counter-productive.

Tax reform is the most difficult and complicated piece in the U.S. budget battle. It is integral to both the Republican House and the Democratic Senate budgets. As in every budget item, there is a conservative vs. liberal confrontation, but tax reform is loaded with more confusing detail, and it adds extra layers of difficulty to the budget debate.

Some liberal and conservative inclinations tend to intersect when the conversation focuses on elimination of tax preferences. But, both sides have their favorite exceptions. Democrats love tax expenditures for the less affluent. Republicans love the preferences they suspect will stimulate growth.

Additionally, there are wide divergences about how the deficit savings from eliminated tax preferences should be used. Republicans like deficit-neutral solutions which invest all savings in lowering rates for growth. Democrats would like to spend those savings, either for compassionate spending or for Keynesian growth stimulus.

More real difficulties arise when tax preferences, individual and corporate, are considered one at a time. This is where powerful lobbying interests intervene. These are the interests that finance campaigns and parties. Regional factors arise, too. The normal political “rules” are often overridden. In some committee votes, it is hard to distinguish Democrats from Republicans.

Three of the four largest individual preferences are interesting examples. The first is the homeowners’ preference, which allows deductions for mortgage interest and real estate taxes. Homeowners’ enthusiasm for those benefits is exceeded, exponentially, by the real estate lobby, including real estate and mortgage firms, sun-belt governors, etc. The lobby, with bi-partisan support, easily defended its prize in the 1986 Tax Reform Act, and again, more easily, in President Bush’s Commission on Tax Reform in 2005.

The other two large preferences are charitable deductions and medical insurance (untaxed income for employees, and a deduction for corporations). Taking on the Little Sisters of the Poor, the big universities, or the United Fund is a fool’s errand. And standing up to powerful unions and corporations is not much easier.

Because these three big preferences, and others, are so well defended, many observers have suggested that placing a limitation on total individual preferences, a la Martin Feldstein, is a better approach. That strategy offers some hope, but it’s no piece of cake, either.

Reforming individual preferences is tough, but corporate preferences are, in some ways, even more perplexing. The last tax reform was achieved, at least partly, by shifting individual tax burdens on to corporations. That was okay in 1986. Today the common wisdom in both parties, and among knowledgeable observers, is that the U.S. corporate income tax rate must be reduced for reasons of international competition.

The task would be easier if individual and corporate income tax reform could be considered separately. Here again, there is a problem. Much of American business is transacted by small companies taxed as individuals. Separating these companies from their corporate competitors may not be practical.

Business operations are scattered over the U.S. supply chains extend everywhere. The tentacles of strong lobbying organizations also extend everywhere. Our system of territorial representation in Congress makes nearly every member a special defender of certain companies, industries, or unions. This factor tends to upset tax reform strategies. Sub-contracts loom large. Majorities appear, and disappear, unexpectedly.

Some budget observers believe that tax reform could be the key to long term fiscal compromise. Instead, some of these extra dimensions could make it the enemy. The devil is always in the details. Tax reform teems with details. Its politics are sometimes treacherous, even for seasoned politicians.

On the positive side, the tax committees of both houses are primed and ready to move forward. Chairman Camp and Baucus, while not exactly political soul-mates, have some similar ideas, a good business relationship, and regular communications. Both parties seem to want to try it.

Speaker Boehner has assigned tax reform the precious number of H.R. 1. If President Obama can extend his Congressional charm offensive, tax reform will never be the odds-makers’ favorite, but it is not out of the question for 2013.

Syndicate content