In the quarter century since Congress last reformed the Tax Code, back in 1986, it seems Washington has worked overtime to create the most inefficient and ineffective globally anti-competitive tax system humankind could dream up.
It’s time to start over — time to start with a blank slate.
The 1986 reforms accomplished a great deal to simplify the Tax Code and promote economic growth by eliminating tax preferences and using the resulting funds to lower the top rate to 28 percent. Unfortunately, those deductions, exclusions and other preferences have returned over the years in the form of approximately $1.3 trillion worth of annual backdoor spending that now litters the Tax Code.
This hidden spending complicates tax filing, distorts economic decision making and slows economic growth. It also means that despite a top individual rate of 39.6 percent, deficits are still far too high. The current Tax Code is badly broken.
The conventional wisdom holds that real reform — reform that reduces or eliminates tax preferences to cut tax rates, simplify the Tax Code, promote economic growth and help to control the national debt — is impossible as long as powerful interests continue to promote the status quo.
But conventional wisdom was turned on its head recently when the two leaders of the Senate tax-writing committee called for starting tax reform with a “blank slate.”
The bold proposal from Chairman Max Baucus and ranking member Orrin Hatch begins by eliminating each and every tax preference. Starting from scratch, as Sens. Baucus and Hatch propose, provides the single best chance to accomplish fundamental tax reform, which could be one of the best ways to get the economy moving.
On the Fiscal Commission (known colloquially as Simpson-Bowles), our decision to take a similar approach — we called it the “zero plan” — was a turning point that truly broke the partisan logjam. At the time, we found eliminating all tax preferences would allow the top individual rate to be reduced to 23 percent and the top corporate rate to 26 percent, while still dedicating some of the revenue to reducing the deficit.
This was a true game changer that made it possible for us to put forward tax reform that accomplished the Republican goal of substantially reducing rates and the Democratic goal of raising new revenue.
Importantly, starting from scratch doesn’t mean that all tax preferences will be eliminated. Instead, it puts the onus on advocates of tax preferences to justify their existence and it requires policymakers to pay for those add-backs with higher rates. We believe most will not pass the cost-benefit analysis and will either be eliminated or phased out. Those deemed to serve important public policy purposes can be added back more efficiently and cost-effectively — for example, by using credits instead of deductions.
On the Fiscal Commission, we put forward an illustrative tax plan that added back a number of tax expenditures in a scaled-back, better targeted form, and achieved a top rate of 28 percent. Former Congressional Budget Office and OMB Director Alice Rivlin and former Sen. Pete Domenici have their own tax plan that includes similar rate reduction. Both plans would increase the progressivity of the Tax Code and, importantly, both would help raise new revenue to help pay down the deficit.
With $1.3 trillion of annual tax preferences, there are plenty of funds available to lower rates, restore worthwhile tax preferences and contribute to deficit reduction. And if we design the reform right, it also can do wonders for economic growth.
Of course, tax reform can’t do all the work on its own. Any successful effort to truly unlock the U.S. economy’s potential must bring our rapidly expanding national debt under control, which means slowing the growth of our unsustainable entitlement programs to match revenues from tax reform, along with other cuts in spending.
Combining tax reform with a broader package, one that also replaces the mindless sequester cuts with larger and smarter spending cuts and entitlement reforms, would represent a tremendous accomplishment.
Agreeing on such a package will not be easy. But the efforts and leadership of Sens. Baucus and Hatch, along with the hard work Ways and Means Committee Chairman Dave Camp has done in the House laying the foundation for reform, make it seem more possible than it has in some time.
Starting with a blank slate doesn’t allow us to avoid the hard choices. But it does make them just a little bit easier. It lets us build the Tax Code we want, rather than chip away from the Tax Code we have. If members of Congress and the administration rise to the challenge, this country’s future will be a whole lot brighter.
