I saw quite a few non-scare-quote serious people discuss the potential for fundamental tax reform the other day. They seem to think it isn't too ridiculous a notion that it might occur in the next let's-say four years. (I think three might have been thrown out, but that was as a range that would improve the possibility.) I think they're ridiculous for thinking this.
Not that we couldn't use some reform. ("Well people do like that reform. Maybe we should get us some.") The problem is the obstacles. They mentioned some, the steepest hurdle being the near impossibility of bipartisan work on tax reform. This is a serious obstacle, and even a Democratic sweep retaking both houses and keeping the executive might not surpass it -- a party with a lock on power fears doing anything big that might upset that lock.
The other problem, though, is the conception of reform and the shibboleths going back to the 1986 Act that everyone holds so dear. There seemed to be a lot of totemism in the room about some parts of that act, including some that in retrospect maybe shouldn't still be such shiny baubles to cling to. [Yes, I am not afraid to end a sentence in a preposition. Get over it.]
Revenue neutrality is the first one. In short order it was recognized that we needed more revenue then the 1986 Act provided, and the deficit situation was bad enough at enactment that people shouldn't have been congratulating themselves so much. Some poor guy even lost his job for facing up to this fact. Depending on our baseline, we likely need more revenue now than revenue neutrality will provide. And what is our baseline? Someone is going to want to reanimate the temporary Bush-the-Lesser tax rates yet again for another monster movie sequel of fiscal destruction. If adults prevail finally and temporary rates are allowed to sunset as promised when enacted (at least for purposes of discussion on hatching a new plan), there is still the stupid annual AMT patch, a legacy of the 86 Act; it technically goes away, so putting in the effect of the patch would cost revenue by conventional definitions, but the politics . . . okay, I'm skipping over that before my head explodes. Anyhow, the short on revenue neutrality is that we have higher priorities and that there are ugly politics if we even try to use it as a point of comparison.
Then there is the tax expenditure budget. Showdown at Gucci Gulch was name-dropped at the aforementioned discussion, and the point made in the book and elsewhere is very valid -- there is a constituency for every tax break, and those who lose a tax break are more motivated than the general population who can benefit a small amount from not having to subsidize said break. There is a failure of imagination here. For people who talk about fundamental tax reform, the game plan is decidedly small ball. Notions have been floated of shaving down deductions as a fail-safe to fix things if Congress cannot act on specific measures. That isn't the fail-safe, that's the whole game.
Bill Bradley's initial reform proposal in (I want to say) 1982, as it pertained to individuals, had a low rate bracket of 14% and a high-rate bracket of 28%. We need not go to the brackets, but we need to look at the deduction portion of his plan. As well as killing some killable deductions and credits, the plan limited personal deductions to 14%, even for high-bracket taxpayers. Currently, a high-income person gets a greater tax benefit than a low-income person on a dollar per dollar basis. If it was a cost of producing income, there are arguments that can be made, but I'm no fool on the politics of carrying the argument. However, if the point of the home mortgage interest deduction is to help people afford homes, why do we care more about subsidizing a wealthy attorney's home ownership than that of the janitor who cleans his office? That's the statement the tax code makes about who we're looking out for. Same with charitable deductions -- charity that costs the attorney more as a matter of marginal utility gets him a bigger charitable deduction than the gift that costs the janitor much more dearly.
The reason to allow personal deductions is the humanistic idea that life costs money, and we will reduce somebody's tax base to allow for this fact. When life costs more money because the affluence is available to finance it, well, we need not be quite so concerned with the higher cost. But we could cut a break of sorts.
I mentioned the AMT earlier. The AMT is a mess of a regime originally designed to make sure that high-income individuals didn't reduce their tax liability too much from piling on a bunch of deductions. Having the savings impact of deductions capped to a rate lower than the marginal tax rate could have much of the same impact, but with a simpler regime. There, meaningful tax simplification but with a softer touch than Attila the Hun or the "Fair Tax" crowd. You don't even have to have personal deductions phase out or expire, just let them wash out as the tax rate rises.
With this approach, you avoid the usual base-broadening problem of every deduction having a constituency. All personal deductions get hit, but none needs to be specifically chopped to reduce subsidies to the affluent and claw back some revenue. Compared to some talk of eliminating all personal deductions or vague asterisks promising to do some base broadening, the constituencies could surrender and call it a victory.
Okay, that was five paragraphs on my second point on conceptual closure after the 1986 Act. I'll throw in another quickie. It didn't really seem to grab the discussion but it's making the rounds in the Cat Food Commission's not-really-a-report and the Ryan Plan [sic]. It's the catnip of top-line rate reductions. This is allegedly made possible through base broadening. It's hard to broaden the base to a degree sufficient to finance the rate cuts that the clowns throw around. There was a lot more to broaden in 1986. (If you're unaware, look up the passive-activity loss rule -- the end of the tax-financed gravy train probably was the major factor in the S&L implosion.) Top-line rates are overly fetishized when the rubber hits the road at effective rates. Look at the effective rates of the top 400 incomes in IRS statistics and you're looking at a tax haven. And if we are comparing rates to other industrialized countries, they all have a VAT. Where we need to fix rates is more akin to where things stood before tax reform became a priority in the 1980's, where we need to look at the equity of taxing an attorney and a hedge fund manager with the same income differently, or having Warren Buffett pay a lower effective tax rate than his secretary. If the solutions is reducing top rates, well, we're gonna need a VAT and we're going to need a bigger standard deduction, and maybe a refundable one at that.
As my introductory post, this is a good demonstration that I know how to have a good time on a Saturday night. If I keep at this thing, I'll hash out some of this at even greater length. For I am not a constitution; I am prolix.
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