There are many ways to restructure the tax code. Elected officials often fail to detect opportunity when they adhere in a path-dependent way to one past model of success, such the 1986 tax reform. An alternative approach where even the acclaimed 1986 effort made at best modest progress would focus on making tax code simpler for taxpayers and improving compliance without adding to IRS costs. This reframing of reform stands a chance of stepping around the partisan wrangling that deters progress on so many other policy fronts.
In recent weeks, IRS Commissioner John Koskinen has been lamenting the Service’s inability to perform its functions well, mostly recently at today’s Tax Policy Center event on the impact of IRS budget cuts. It not only continues to lose staff, but less experienced staff quickly must replace a large fraction of senior employees who are leaving.
At the same time, congressional Republicans have been finding fault with much of what the IRS does, from its inability to regulate the activities of social welfare 501(c)(4) organizations to its implementation of the Affordable Care Act. Democrats say the solution is a bigger IRS budget. Republicans say it is a smaller one. But there is an alternative choice.
Focus tax reform on an objective almost never before given priority: developing a system that is less costly for taxpayers to comply with, mostly through simplification of existing laws. Simultaneously modify laws where IRS enforcement is difficult or impossible or too costly ever to do well. Such an effort would not necessarily require base broadening, though that often would be consistent. For instance, rather than engaging in a non-productive debate over whether to eliminate or expand refundable tax credits for low-income households, Congress could simply replace the existing credits with versions that are easier for taxpayers to understand and for the IRS to administer.
Put everything on the table, ranging from business deductions to multiple capital gains tax rates to complexity of retirement plan options to refundable credits that go mainly to the poor. Include many of the small items like mileage deductions that can be vastly simplified.
The first step in such an effort would be for the IRS to better understand known error rates for each preference and “program” based partly upon the audit data it keeps. Believe it or not, the agency has never done any good comprehensive study on this, though on occasion it has tried to measure the extent of noncompliance in rough terms.
And the IRS has never conducted this type of research to inform policy, as opposed to allocating internal audit functions. IRS should study taxpayer time costs, error rates, causes of error, costs of auditing, and administrative aspects of every program put into the tax code. For instance, although relatively easy to do, it has never really distinguished in its studies what it can’t know or can’t enforce well from the error rates that it can find under some audit technique.
The second step would be for the IRS and its colleagues at the Treasury’s Office of Tax Policy to be prepared, at least in a tax reform setting, to acknowledge what provisions it cannot monitor at a reasonable cost. For instance, it can estimate compliance with wages reported to the IRS on W-2 forms, but it seems fairly certain that it has little idea of how much charitable contributions of clothing are overvalued. Even if it did, it has no way to efficiently allocate resources to monitor such deductions.
I recognize that a balancing act is required, since IRS doesn’t want to encourage even more noncompliance. But an agency can’t engage in continuous improvement if it doesn’t study and acknowledge its problems in the first place. Indeed, some of IRS’s recent public conflicts, such as over the tax-exempt status of Tea Party and other social welfare organizations, stemmed from what every tax policy analyst has always known: that limited resources devoted to vague or hard-to-enforce law eventually can lead to disaster.
With attention to individual simplification, along with the improved compliance that comes from removal of laws that can’t be enforced, both parties could claim a victory. A simpler and more efficient tax system conforms to both progressive and conservative principles.
Unlike more money for audit, moreover, making the system more administrable and simpler modestly increases national well-being.
In a fairly comprehensive study I undertook for the American Bar Association and the American Institute of Certified Accountants many years ago, I found that expanding IRS audit resources was likely to raise more than was spent, ranging from $2 to $7, depending upon type of return, for every dollar spent. I doubt the conclusion has changed greatly since then. But while more auditors would help redistribute the tax burden in favor of compliant taxpayers, there’s no gain and a likely loss in output by taking workers away from more productive activities.
Administrative reform and simplification, on the other hand, can reduce noncompliance while increasing the time that taxpayers can devote to more productive pursuits. Of course, to achieve this goal, leaders of both parties have to cooperate to make changes that benefit the public, even when it gives them no partisan advantage.
This column originally appeared on TaxVox.
In his budget proposal, President Obama would raise capital gains taxes as a way to finance middle class tax relief. Along with many Republicans, he also supports tax rate cuts for business and efforts to prevent multinational corporations from avoiding U. S. taxation.
This raises an intriguing possibility. Why not pay for at least some corporate tax cuts with higher taxes on individuals on their receipts of capital gains or similar returns? In effect, as it becomes increasingly difficult to find a workable way to tax profits of the largest businesses, largely multinational companies, why not tax shareholders directly?
Most proposals to deal with the complexities of international taxation wrestle with how to tax corporations based on their geographical location. But as Martin Sullivan of Tax Notes said years ago, what does it mean to base taxes on a company’s easily-reassigned mailing address when its products are produced, consumed, researched, and administered in many places?
By contrast, individuals usually do maintain residence primarily in one country. Thus, reducing corporate taxes while increasing shareholder taxes on U.S. residents largely avoids this residence problem. Indeed, many proposals, such as a recent one by Eric Toder and Alan Viard, move in this direction. While such a tradeoff is not a perfect solution, it makes the taxation of the wealthy easier to administer and less prone to today’s corporate shelter games.
Many have made the case for why cutting corporate rates is sound policy. On what policy grounds can Obama’s plan for raising taxes on capital gains fit into this story?
Much of the publicity about taxing the rich focuses on their individual tax rate. But many very wealthy people avoid paying individual taxes on their capital income simply by never selling stock, real estate, or other assets on which they have accrued gains. That’s because, at death, the law forgives all capital gains taxes on unsold assets.
The very wealthy, moreover, tend to realize a fairly small share of their accrued gains and an even smaller share than those who are merely wealthy. It makes sense: the nouveaux riche seldom become wealthy unless they continually reinvest their earnings. And when they want to consume more, they can do so through means other than selling assets, such as borrowing.
Warren Buffett was famous for claiming that he paid lower tax rates than his secretary, alluding in part to his capital gains rate versus her ordinary tax rate on salary. But Buffett doesn’t just pay a modest capital gains tax rate (it was 15 percent when he made his claim and about 25 percent now). On his total economic income, including unrealized gains, it’s doubtful that his personal taxes add up to more than 5 percent.
At the same time, many of the wealthy do pay significant tax in other ways. If they own stock, they effectively bear some share of the burden of the corporate tax. Real estate taxes can also be significant and not merely reflect services received by local governments. Decades ago I found that more tax was collected on capital income through the corporate tax than the personal tax. Today, the story is more complicated, since many domestic businesses have converted to partnerships and Subchapter S corporations, where partners and shareholders pay individual income tax on profits.
The President would raise the capital gains rate and tax accrued gains at death. This would encourage taxpayers to recognize gains earlier, since waiting until death would no longer eliminate taxation on gains unrealized until then. The proposal would effectively capture hundreds of billions of dollars of untaxed gains that forever escape taxation under current law.
Trading a lower corporate tax rate for higher taxes on capital gains could also result in a more progressive tax system since many corporate shares sit in retirement plans and charitable endowments. It would reduce to hold onto assets—in tax parlance, lock-in—and the incentive to engage in tax sheltering. There’s also a potential one-time gain in productivity, to the extent that the proposal taxes some past gains earned but untaxed, as such taxes would have less effect on future behavior than the taxation of current and future returns from business.
Tough issues would remain. Real reform almost always means winners and losers. For instance, how would a proposal deal with higher capital gains taxes for non-corporate partners and owners of real estate? Toder and Viard, for instance, would apply higher individual taxes only on owners of publicly-traded companies.
Still, some increase in capital gains taxes could help finance corporate tax reform without reducing the net taxes on the wealthy. It is exactly the type of real world trade-off that both Democrats and Republicans must consider if they are serious about corporate tax reform.
This column originally appeared on TaxVox.
President Obama’s tax proposals for the middle class were a key element of his State of the Union address. But they represent only relatively modest efforts to create subsidies through the tax code rather than through other departments of government. Looked at broadly, many only tinker around the edges of tax policy and count on an overloaded and troubled agency, the IRS, to administer them.
Will $320 billion of tax increases finance very much?
The President proposes $320 billion in tax increases on the wealthy. It sounds like a lot. But how much would it finance in expenditures and additional tax breaks, assuming it is all spent rather than used to reduce the deficit? Well, there are approximately 320 million Americans, so the proposal would garner about $1,000 per person. But, then again, the $320 billion would be raised over ten years, so that’s about $100 per person per year that could be financed.
Now compare the $100 per year with what we already spend. Add together federal, state, and local spending plus tax subsidies (and the President would “spend” a good deal of his additional revenue on new tax subsidies), and the figure comes out to more than $20,000 per person. And that spending is scheduled to rise by an average of several thousand dollars per year over the same ten year period, due more to (hoped for) economic growth than anything else.
None of these observations speaks for or against the proposals. I like some of them, don’t like others. But if you want to have a significant impact on the budget and on the well-being of citizens, concentrate on where the money is.
Should we throw even more subsidies into the tax code?
Like almost all his recent predecessors, the President talks in his State of the Union address about tax simplification, but in almost the same breath he proposes a range of new tax subsidies. It’s an old story. Tax cuts show up as “smaller” government to those who simply count up net government revenue as a measure of government size. According to that theory, we could achieve dramatically limited government or no government at all if we put all expenditures into the tax code, thereby collecting negative taxes on people, at least as long as we run deficits.
Huge jurisdictional problems also lead to more and more being put into the tax code. Discretionary spending is capped; tax subsidies are not. Congressional tax committees can use increased revenues to pay for increased tax subsidies, but they do not have the jurisdictional authority to spend additional tax revenues on higher levels of spending, or, on the flip side, to reduce many items of direct spending to pay for lower tax rates.
Now I’m not suggesting that a new tax subsidy is necessarily more complex than a new expenditure. But it does raise the issue of whether the IRS is the right agency to administer the subsidy. All of this is coming at a time when the IRS has lost significant resources, the Taxpayer Advocate suggests we should be ready for a horrible filing season in which taxpayers will have difficulty getting ahold of someone in IRS to advise them, and many in the IRS remain disheartened and have been pushed into a bunker mentality that fears bad publicity more than bad administration.
This column originally appeared on TaxVox.
House Ways and Means Committee Chair Dave Camp deserves credit for proposing a tax reform that takes on many special interests, something too few other elected officials are willing to do. But one provision mistakenly threatens the survival of most community foundations without improving the tax system or strengthening the charitable community.
The proposal would effectively eliminate most donor advised funds (DAFs), the major source of revenues to community foundations, so they could no longer provide long-term support for local and regional charitable activities. Instead, those funds would need to pay out all their assets over a period of five years.
DAFs support community foundations in two ways. First, donors pay about one percent of asset value to the foundation for sponsoring the fund. Second, community foundations distribute donor gifts to many local charities. By simplifying giving and reducing costs, they make it possible for people who are not wealthy to endow charitable activities.
Requiring a community foundation to pay out all its assets over five years is equivalent to telling the Ford Foundation that it, too, must pay out all of its endowment over a short period of time. But the draft bill only targets those with limited funds, while it leaves the really big guys like Ford alone.
Usually, I analyze tax policy as a disinterested observer. But as chair of a community foundation called ACT for Alexandria, I have a personal interest in this issue.
So let me tell you how this proposal would lead to the demise of many of our activities and, likely, the community foundation itself.
Each year we engage in a one-day fundraising effort for the charities of Alexandria, VA, a city of about 145,000 across the Potomac River from Washington, DC. This year we raised over $1 million for 121 local charities, and many contributions to support the effort itself, not just the charitable contributions themselves, came from our donor advised funds.
The fees we earned from the funds supported our program to train local charities on how to better use social media and do online fundraising. No one else in the community does this coordination and training.
In addition, several of our donors create DAFs, often small, to engage their families in philanthropic efforts. By doing so, they encourage a new generation to make charitable giving part of their lifestyles.
DAFs give donors flexibility to vary their gifts as circumstances change. For instance, one of our funds provides long-term support for schools in Afghanistan through U.S.-based charities, but there is no guarantee that any particular Afghanistan project would be strong enough to merit a direct permanent endowment. Other funds support a long-term examination of early childhood education opportunities in Alexandria, a project likely to change as needs change. DAFs or equivalent funds also allow “giving circles” that combine small gifts to assist an activity without having to create a new charity every time.
Without these funds, we likely would be unable to support a grant program for capacity building and training of local nonprofit leaders.
I doubt seriously that Chairman Camp’s staff saw fully how they would wipe out most community foundations and confine endowment giving only to the rich. By making it more complicated and expensive to engage in such activity, they would move almost all endowment decision-making to elite, often established institutions where the average citizen has little or no voice and where the operational expenses are greater.
Why are critics of DAFs so worried about someone having a say over an annual grant of $5,000 out of an endowment but not when the President of Harvard decides over time how to spend billions of dollars out of the income from an endowment?
There are legitimate concerns over how such donor advised funds should be regulated. It may even be possible to design a proposal for a minimum annual payout, though, if badly designed, such a limitation could curb the ability of some people to build up assets to make a major gift to try to achieve some large charitable purpose.
The very small literature I have seen arguing for this type of proposal entangles DAFs and community foundations with separable issues. For instance, one can argue about the extent to which givers to charity should be allowed special capital gains treatment. But those discussions go well beyond DAFs, and removing DAFs as a source of more endowed funds hardly targets the perceived problem.
Still, I also understand why tax staff and policymakers sometimes see charities as just another special interest. The charitable sector needs to go beyond its “we’re all good, leave us alone” mantra, and address real problems as they arise.
There are ways for Congress to reform the tax laws that would raise revenues and strengthen the charitable sector. But this DAF proposal would wipe out most community foundations, increase administrative costs, and raise nothing or almost nothing for Treasury.
This post originally appeared on TaxVox. An earlier version of this column stated that a fund-raising effort by ACT for Alexandria supported over 200 charities; the corrected number is 121 charities
This post originally appeared on TaxVox, the Tax Policy Center blog.
By proposing a far-reaching and detailed rewrite of the Revenue Code, House Ways and Means Committee Chair Dave Camp (R-MI) did something very few elected officials have done in recent years: He stuck out his neck and proposed radical reform. The initial press response has focused on politics and concluded that neither Republicans nor Democrats will be able to take on the special interests, that there is too much partisan gridlock, and that the plan is going nowhere.
But such responses largely ignore the history of successful reforms and forget that some policymakers do care about policy. If the goal is to conquer a mountain, someone has to start by building a common basecamp.
Almost any major systemic reform that does more than give away money creates losers. Someone always has to pay for whatever new use of resources the reform seeks—in this case, tax rate reduction and a leaner code with fewer complications. But politicians hate identifying losers. We voters punish them for their candor, which is why they nearly always increase deficits to achieve their goals and leave it to a future Congress to identify the losers who pay the bill.
With his full-blown tax reform proposal, Chairman Camp decided to lead and proposed repealing many popular tax breaks. There’s a lot I like and some things I don’t like in his proposal, but the simple fact is that a well-designed comprehensive alternative to current law can change the burden of proof. Change a few items, and each interest group argues that it was unfairly picked on. Put forward an alternative that takes on almost all preferences, and each interest then needs to justify why it deserves special treatment not accorded others.
The prospect for any reform is nil if no leaders do what Camp did and step up to the plate. The process is not one of instant epiphany. Rather it slowly builds support. Those who first propose change may increase the odds of success from 5 percent to 10 percent. Others who follow further improve those odds. If we reject out of hand all ideas that start with less than a 50 percent chance of success, we’d probably never reform anything.
It often takes modest support by others to move the process forward. In 1985, President Reagan and House Ways & Means Committee chair Dan Rostenkowski started the legislative process that yielded the Tax Reform Act of 1986 by simply agreeing not to criticize each other while the measure went through committee. Like Speaker Boehner today, Speaker O’Neill wasn’t enthusiastic about reform then, but Rostenkowski was able to proceed anyway.
In 1985, Rostenkowski knew he could pass a Democratic bill. But he knew it would go next to the GOP-controlled Senate Finance Committee. Each party would have a turn and a final agreement would come from a bipartisan conference committee. If House GOP leaders let Camp mark-up his bill now, Democrats would have their turn, at least this year, in the Senate. At least so far, both President Obama and senior Ways & Means Democrat Sandy Levin (D-MI) have avoided any major criticism of Camp’s plan, but one wonders if Democrats aren’t going to forego an opportunity, once again joining Republicans in deciding in advance that nothing substantial can be done, so it won’t.
Leadership is seldom about achieving results that can be predicted with certainly. More often it requires using your clout to change the process or reframe the debate in ways more likely to serve the public. It’s certainly about more than protecting your party’s incumbents in the next election regardless of the policy consequences.
When I served as economic coordinator and original organizer of the 1984 Treasury study that led to the ’86 Act, it was a time when books declared major tax reform the “impossible dream.” Sound familiar? In the face of that dispiriting commentary, I tried to encourage the Treasury staff with what I call the “hopper theory” of democracy: the more good things you put in the hopper, the more good things are likely to come out. By this reckoning, Chairman Camp has already won.
If we want successful companies to contribute to the economy fairly, what should we be asking them for? More corporate income tax? A higher minimum wage? Health insurance for employees? More profit-sharing for employees? Restricted-stock payments of highly paid executives, so they can’t succeed individually when they fail their workers and shareholders?
We’ve tried all these approaches, but at different times and in a discombobulated way.
The corporate income tax, which once raised far more revenue than the individual income tax, now applies mainly to multinational companies, which find ways to hide their income in low-tax countries. Domestic firms often avoid the tax altogether through partnerships or similar organizational structures.
The minimum wage has been allowed to erode substantially. I earned $1.25 an hour while in high school in the mid-1960s; if that amount had grown at the same rate as per capita personal income, high school kids and others would now be earning $20 instead of $7.25.
Health insurance mandates for many employers is our new form of minimum wage. The ACA’s $2,000-per-employee penalty for larger employers that do not provide insurance is essentially an additional “minimum wage” requirement of at least $10 an hour, either in the form of a penalty or health insurance.
Profit sharing was at one time touted as the way to instill better work habits and allow employees to share in a firm’s success. Many employees, however, put all their savings in that one investment and got stuck with huge losses when their firms declined.
A 1993 Tax Act limited to $1 million annually the amount of cash and similar compensation that could be paid to top executives and still get a corporate tax deduction. Post-reform, stock options flourished, as did a more uneven distribution of income within firms.
More recent proposals to reform the corporate income tax set minimum taxes on multinational companies, regardless of the country in which the income was earned; increase the minimum wage on all firms; bump up or reducing the mandate on larger employers to provide health insurance (by adjusting either what services the insurance must provide or the size of the penalty for not providing insurance); regulate companies to disclose how unequal their compensation packages are; and require executives, particularly in financial companies, to invest more in the stocks and bonds that couldn’t be sold immediately and would fall in value should their companies falter.
What drives all these proposals, I think, is the notion that large organizations only become that way by being successful and that they owe the public something in return for this success. At some point, almost all companies achieve their size by generating above-average profits and sales growth. The Wal-Marts and Apples and Mercks of today, the General Motors and U.S. Steels and Pennsylvania Railroads of yesterday, have or had more power and money than most. Did they get there only through the hard work and ingenuity of a few people who deserve most of the rewards? Or were they also lucky? The first out of the block? The beneficiaries of scale economies, where only a few companies would survive or the winner would take all? Did they get government help along the way, perhaps taking advantage of the basic research that served as a prelude to their development? Or the protections of a developed legal system, along with a bankruptcy law that limited their losses? If so, doesn’t that legitimize the discussion of how their gains might be shared, either with their own employees or the public?
If we truly want to create a 21st century agenda, I wonder if we could come up with better, more efficient, and fairer policies by asking the broader question than by piecemeal approaches. The corporate income tax, for instance, has been put forward by the chairs of the congressional tax-writing committees, as well as the president, as a ripe candidate for reform. Yet, however much I might favor such reform as a pure tax issue, it’s only a piece of these broader redistributional questions. Might it be better, for instance, to abandon the attempt to assess any extra layer of corporate income tax, and instead ask larger firms to take a greater role in accepting apprentices, hiring workers during a downturn, sharing profits with workers, providing minimum levels of compensation but not necessarily all in health insurance, and restricting the ability of their higher-paid managers to walk away with bundles even while their firms fail?
Obviously, the devil is in the details. But we should at least have the conversation.
Dateline: January 2014. Federal government shuts down completely.
Day 1. Mall, Washington, DC. Park Police decide shutdown again requires barring access to war memorials and the grounds of the Washington, Lincoln, and Jefferson monuments. Veterans rise up in anger and push back barricades. “If you’re furloughed, how can you keep us from entering the parks?” asks Joe Laploski, an Iraqi veteran from New Rochelle, NY. Park Police assign unpaid legal interns to determine whether Park Police should arrest themselves for working.
Day 2. White House. In hastily called press conference, President Obama announces major plan to deal with the national emergency. Enforcement on malls will be sustained, lest someone fall in the Tidal Basin and sue the government. Government debt will thereby be reduced, since Park Police cost less than those future lawsuits, at least on an expected basis.
Day 3. Capitol. Lights go out. Speaker Boehner lost underground. Democrats offer to fund search party, but, invoking the Hastert rule (requiring agreement by a majority of the majority party to act) and unable to decide whether they want to find him, Tea Party refuses.
Day 4. Longworth House Office Building. Democrats send search party after Boehner anyway. Find flasks of aged whiskey hidden by the late former Ways and Means Committee Chair Wilbur Mills two levels below the committee room where he presided. Debate ensues over whether imbibing is an essential government function. Inspired by former Occupy Wall Street supporters, Democrats decide to represent the activity as unity with the “99 percent,” who normally can’t afford such expensive booze.
Day 5. Treasury Department. Electronic payments of billions of government checks and bills stop. Secretary Lew called to emergency meeting at the White House to determine how much blame to assign to Republicans.
Day 6. Oklahoma City. Local Tea Party members claim the IRS is targeting them, citing delayed refund checks as proof. Back in Washington, House Oversight and Government Reform Committee decides to hold hearings in the dark.
Day 7. Near Capitol. Republican staffers gather at a local bar to debate how to get work done during the impasse. Consider asking the guy in charge of the lights for help, until they discover that position no longer exists because of the sequester. Boehner still missing.
Day 8. White House. President Obama plans national address during primetime. He asks the Democratic Party to pay for the speechwriters. Local TV stations refuse to broadcast the president’s speech unless their invoices for airing “Army Strong” recruiting commercials are paid.
Day 9. Treasury Department. Secretary Lew tries to issue checks to TV stations. In a 5-4 decision, the Supreme Court bars him from doing so until he lays out the precise legal priority for billions of unpaid bills.
Day 10. Princeton, NJ. Despite the worldwide recession induced by the shutdown, foreigners still flock to outstanding US obligations, and interest rates on US government securities tumble instead of rise. In a New York Times op-ed, Paul Krugman argues that at this low rate we should borrow all we can—unless it would pay for a Republican tax cut.
Day 11. Treasury Department. In response to the House Oversight Committee’s hearings, Treasury’s Inspector General issues report that Republicans were indeed targeted, indicating as proof that their delayed refund checks were bigger on average than those for Democrats. However, no crime was committed, he asserts.
Day 12. White House. President issues a statement that IRS targeting of Republicans is inexcusable. Fires top IRS data processing personnel and replaces commissioner with top executive from Avon Products with an unblemished record in taxes and data processing because she has never worked in either field.
Day 13. Sacramento. Governor Brown announces that millions of Californians are now insured under Obamacare. He asks that no penalties be assessed on those getting thousands of dollars in excess benefits since recordkeeping was impossible. On Meet the Press, Senator Cruz expresses amazement that the shutdown he favored affects every government program but Obamacare.
Day 14. White House. President Obama launches new peace initiative. He asks Hassan Rouhani of Iran and Bashar al-Assad of Syria to hire their own nuclear and chemical weapons inspectors, claiming that the U.S. shouldn’t have to pay to clean up other countries’ messes. President Putin offers to mediate and contribute Russian oil revenues.
Day 15. Capitol. Boehner found. Claims, like always, he knew exactly where he stood. Negotiates agreement with president on a continuing resolution to fund government until after congressional elections. Congress then shuts itself down until December 2014.
Day 16. Russell Senate Office Building. Before departing, Chairman Camp of the Ways and Means Committee and Chairman Baucus of the Senate Finance Committee issue a 6,700-page document with complex details on how to structure a major tax reform. Congressional leaders promise to take up issue immediately…in the next Congress.
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.