Tax Reform: Start with the FundamentalsPosted: August 22, 2017
This post originally appeared on TaxVox.
For the umpteenth time, Congress and the Trump Administration are going back to the tax reform drawing board, just as they have had to do for health reform. These policymakers could help themselves by recognizing that you can’t go back to a place you’ve never been.
Many policymakers look to the Tax Reform Act of 1986 as a model for successful reform, but largely ignore its lessons. Here is one of the most important: the success of the ’86 act was built on a solid core—a set of fundamental principles accepted by conservatives and liberals alike. They included equal justice for those in equal circumstances, simplicity, and–to a large extent–efficiency.
Agreeing on that core made it possible for reformers of all stripes to first address issues of common concern before turning to more conflict-laden issues, such as the taxation of capital income. While the political process of passing the ’86 act bent those principles, it never broke them. And the result was the only comprehensive revenue-neutral reform in the hundred-year history of the income tax.
Don’t get me wrong, 2017 is not a replay of 1986. Heraclitus was right: you can’t step into the same stream twice. But you can learn from previous crossings.
To start, it’s a myth that there was more friendly cooperation in the mid-1980s. Indeed, political war raged both within and between political parties.
Democrats were smarting over their electoral losses while Republicans fought over whether President Reagan was “being Reagan” whenever he did something one faction disliked.
Within the Treasury Department, extreme supply-siders who held that tax cuts paid for themselves fought with those who favored cleaning up the tax code rather than simply giving away money through tax cuts. Even some reformers questioned whether they should spend time on a tax reform study commissioned by President Reagan, which was largely viewed as an attempt to avoid debating tax issues during the 1984 presidential campaign.
In early 1984 when I became the economic coordinator of Treasury’s tax reform study, people in the Office of Tax Analysis were struggling over how to start. Should we focus on consumption taxes or income taxes? Should the Administration consider an add-on value added tax to finance a smaller income tax? Should we aim for a modest bill or the more comprehensive plan the Administration eventually championed? Should we expand tax breaks for business investment or pare them down to finance lower rates?
As an initial step, I encouraged Treasury staff to divide the overall reform effort into about twenty modules, each covering dozens of specific tax code provisions. Almost everything was on the table: pensions; housing; health; treatment of marriage, children, and the elderly; tax shelters; capital gains; depreciation; and international taxation, to mention only a few. We prepared briefs for Treasury Secretary Donald Regan on how to reform each area, and asked him to keep an open mind about politically difficult choices at this early stage and leave compromises of the principled tax reform options to later political bargaining.
To establish a solid core of reforms, we first dealt with items that would be common among an ideal income or consumption tax, except for taxation of capital income. While we aimed for roughly the same level of progressivity for the overall tax system as the then-current tax code, we did not focus on the progressivity of each particular provision. We recommended killing an inefficient subsidy favoring low- or middle-income taxpayers since on average we could hold those households harmless by reducing their tax rates.
Today’s reformers would benefit by creating a similar core on which to build reform. For example, defenders of the status quo would have a harder time making their case if reformers can show that a new tax system would increase charitable giving, support home ownership, make education more accessible, or protect retirees without losing as much tax revenue as the current system.
Similarly, they could simplify multiple higher education subsidies, capital gains taxation, and various definitions of a “child.” They could reduce penalties on marriage and on some families with children. And they could curb tax-driven investments without constraining economic decisions.
Contrast this approach with the flailing so far, where elected officials began by proclaiming support for cutting taxes on corporations and then, by extension, partnerships and the middle class. At best that’s like announcing a low purchase price for both new luxury and middle-income condos before ever designing the building housing them. Lawmakers would have much more success by first carefully creating a solid foundation for tax reform and then building out the new reforms.