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Why tax reform is not as simple as it sounds

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An earlier version of this column incorrectly referred to the Committee for a Responsible Federal Budget as the Center for a Responsible Federal Budget. It has been corrected.


         Why tax reform is not as simple as it sounds

Lower tax rates, a simpler tax code, less time and money devoted to tax avoidance, compliance and preparation: Who isn’t in favor of tax reform?

Treasury Secretary Steve Mnuchin was upbeat about the prospects for a major overhaul of the tax code, even as the Republican bill to repeal and replace Obamacare was going down to implicit defeat in the House of Representatives on Friday. (House Speaker Paul Ryan pulled the bill because he lacked the votes.)

“Health care is a very, very complicated issue,” Mnuchin said Friday at a forum hosted by Axios. Comprehensive tax reform “is a lot simpler.”

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Americans for Tax Reform Founder and President Grover Norquist on why the GOP’s failed healthcare reform makes tax reform harder. Photo credit: Getty Images.

He went on to explain why. “There is very, very strong support” for the goals of tax reform,” he said. (Keep an eye on Mnuchin’s preference for using the double “very.”) Those include tax simplification, lower income tax rates for the middle class and a reduction in the corporate tax rate to make U.S. businesses more competitive.

What’s not to like? The benefits seem universal. It’s those devilish details that muck things up.

There are major party differences in the approach to tax reform. For example, Republican supply-siders want to cut top tax rates to incentivize work while Democrats favor a more progressive tax code to reduce the burden on low and middle-income Americans.

There are intra-party differences as well, including whether tax reform must be revenue neutral and the advisability of enacting a border-adjustment tax, which would tax imports and exempt exports. Then there are the constraints imposed by using budget reconciliation, an expedited process for tax-and-spending legislation that doesn’t allow for Senate filibuster.

But the real impediment to tax reform isn’t procedural, left versus right, or which industries benefit from a BAT. The real issue is my tax break versus yours.

Everyone wants tax reform until it comes to sacrificing his or her deduction, exclusion or exemption. Therein lies the problem. The only way to lower tax rates without widening the deficit is to close every last loophole, from the huge and popular — the exclusion of employer-sponsored health care and 401-k contributions, the preferential treatment of capital gains, the mortgage interest deduction — to the obscure and arcane (”credit for holders of zone academy bonds”).


         Why tax reform is not as simple as it sounds

Because these provisions are designed to encourage what the government deems to be “good” behavior — home ownership was considered a desirable goal until the housing bubble burst in 2007, leaving devastation in its wake — or to help favored groups of taxpayers, they act as alternatives to direct spending programs. Hence, the name “tax expenditures.”

Unlike federal spending, tax expenditures are not subject to annual congressional appropriations. They are much less transparent than spending on benefit programs. And they encourage an inefficient allocation of resources by incentivizing tax-preferred behavior.

But just try to eliminate any, or even a portion, of these tax breaks, and listen to the affected parties howl!

The Joint Committee on Taxation projects total tax expenditures of $1.6 trillion in 2017, the highest on record. That does not imply an equal revenue loss to the Treasury because repealing a tax break produces behavioral changes as well as interactive effects, according to Marc Goldwein, senior policy director at the Committee for a Responsible Federal Budget.

If tax reform were “a lot simpler” than health care, Congress would have delivered something by now. Instead, the Tax Reform Act of 1986 remains the last best hope for something similar.

“Health care is complicated because it’s one-sixth of the economy,” Goldwein says. “Taxes are also one-sixth of the economy.”

A reduction in the corporate tax rate should be a no-brainer. If U.S. companies are incorporating overseas purely to take advantage of the more favorable tax treatment, then reducing the current 35% statutory rate, the highest among developed nations, is a lot simpler than punishing them for leaving.

While it’s true that U.S. companies pay an average effective tax rate somewhere in the high 20s, the effort requires staffs of highly paid tax lawyers. This is the very definition of inefficient resource allocation.

The fact that everyone wants tax reform of some kind is no guarantee of producing a bill or ensuring its passage. The demise of the American Health Care Act suggests that single-party control of both houses of Congress and the executive branch is no panacea.

Real tax reform, not merely tweaking tax rates around the edges, should aim to achieve basic, yet lofty, goals. It should simplify the increasingly complex tax code to minimize the time and money devoted to compliance. It should create incentives to work, save and invest. It should encourage individuals and businesses to make decisions for economic reasons, not tax avoidance.

And it should seek to make the U.S. more competitive globally.

With real tax reform, April 15 would be just another spring day.

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