Tax Reform Can Be an Essential Part of Reducing the Debt

The recent announcement from Senators Baucus and Hatch to pursue tax reform via a "blank slate" approach is incredibly encouraging. As CRFB Board Member Gene Steuerle has argued, it could be revolutionary. Starting by eliminating all tax preferences and requiring policymakers to justify and pay for any add-backs may represent the best chance for reducing tax rates, broadening the tax base, promoting economic growth, and reducing the deficit.

Rate-lowering, base-broadening corporate and individual tax reform can significantly improve competitiveness and economic growth. However, failing to reduce the deficit in the process would be a huge missed opportunity for economic growth down the road.

As we’ve explained before, our debt problems are still far from solved. To put the debt on a clear downward path as a share of the economy, by our calculations, at least $2.2 trillion of savings is needed over the next decade. Though much of those savings can and should come from spending cuts and entitlement reforms, it would be a mistake to radically overhaul the entire tax code without making some dent in our country’s debt problem.

In 2013, there will be about $1.3 trillion of spending in the tax code, leaving plenty of funds for both rate and deficit reduction if we eliminate or reform many of the tax expenditures. For reference, the new Simpson-Bowles Bipartisan Path Forward dedicates the equivalent of about $60 billion per year of tax expenditures to deficit reduction.

^{Source: CBO, Joint Committee on Taxation}

Achieving this revenue target relative to the “blank slate” approach would mean that of the $1.3 trillion of base broadening, only 5 percent would go to deficit reduction; the remaining 95 percent could be dedicated to rate reduction or tax expenditure restoration.

In comparison to the size of the tax expenditure budget, this amount of additional revenue is small. But relative to our debt problem, it can make a real difference – moving us more than one quarter of the way toward the $2.2 trillion in savings needs to put debt on a downward path.

Importantly, tax reform should be seen as a complement to, not a substitute for, entitlement reform. The aging of the population and growing health care costs are causing the real pressure on the budget and necessitates structural entitlement reform to bring our long-term debt problem under control and protect the beneficiaries who rely on these programs. Failure to reform our entitlement programs will necessarily result in a failure to achieve long-term fiscal sustainability.

On the other hand, opportunities to put $1.3 trillion of annual revenue on the table are few and far between. To not dedicate a small portion of that revenue to help pay down the debt would be a missed opportunity we may not see again for quite some time.