How to Design Tax Reform: 8 Lessons from 1986

This post originally appeared on Forbes.

Saying that one is for tax reform doesn’t provide much information about what is being sought or how to do it. Potential options extend almost infinitely, as do amendments to any set of options. So how does one both focus and ensure that reform, proposed or enacted, serves the public in a meaningful way? Here I identify eight lessons that were vital to the organization of the Treasury study (“Treasury I”) that led to the Tax Reform Act of 1986, the only comprehensive base-broadening tax reform in the hundred-plus history of the income tax

  1. Know the unique requirements and opportunities of the time. No past reform is repeatable. Today is not yesterday. Society today has new needs, different things to fix, novel opportunities, and changing leadership. The 1986 reform was made possible by many factors, including growing tax shelters that everyone agreed were unfair and inefficient, a President who cared about tax rates more than just about anything else, high levels of productivity as baby boomers moved into their peak earning years, Congressional leaders like Senators Bill Bradley and Jack Kemp who had been promoting tax reform, and budget acts in 1982 and 1984, along with Social Security reform in 1983, that left room for at least a reform that didn’t have to raise revenues.
  2. Don’t try to build up reform out of a stack of wants. The more politicians try to organize reform by supporting a bunch of giveaways, as opposed to allowing tax experts to give them viable options for fixing different parts of the system, the more that they are likely to suggest provisions that don’t add up, are inconsistent, fail to meet stated objectives, can’t be administered, and cause other unintended consequences.
  3. Use principles, not symbols, to drive choices. I’m not so naive as to believe that symbols aren’t important. That’s why every tax bill, no matter how much it deforms, tends to get the label of “reform.” But principles should guide where one is going, and create borders to deter consideration of items that don’t meet any principle well. Tax policy principles center on:  equal justice or equal treatment of equals or “horizontal equity;” efficiency; progressivity (though the degree is open to dispute, the principle is not, since, among other reasons, those with no income can’t pay tax); limits on the disincentives to work, save, or invest that are inherent in any tax; and “administrability,” or avoiding both high enforcement costs and the corruption that rises when cheating can’t be controlled.
  4. Build a baseby focusing on those particular principles, like equal justice, accepted by conservatives, liberals, and independents alike. The main fight between political parties over many decades has been between two principles: progressivity and avoidance of the distortions that higher tax rates create. That still leaves huge amounts of the tax system to be reformed on the basis of concerns that are widely shared. When the roof leaks, families can work together to fix it even if they still are in conflict over whether to spend money on a new bed or sofa.
  5. Always keep in mind the balance sheet within both the tax system and the broader budget. Nothing deters a reform process more than trying to give away money without immediately calculating who will pay the bill—whether through tax increases to offset the tax cuts, spending decreases, or rising debt and interest costs to be paid by future generations.
  6. Engage those health, housing, charity, pension, and other policies that are woven into the tax code. With about one quarter of all federal subsidies lying within the tax rather than expenditure system, these issues are hard to dodge even in modest reforms and impossible to avoid in comprehensive reform. Whether it’s the hundreds of billions of dollars spent on the tax subsidy for employer-provided insurance, or housing tax subsidies that cost more than the budget of the Department of Housing and Urban Development (HUD), tax reform almost inevitably will affect those policies. To the extent that tax subsidies are maintained, they should still be reformed to be more effective in, say, increasing charitable giving or promoting adequate retirement saving.
  7. Gather evidence continually, rather than waiting to provide ex post apologetics for a final proposal. Among the many reasons for success in 1986, Treasury and IRS got very busy gathering evidence on growing problems such as the tax shelters of those days, on who benefited from various provisions, and on what the academic literature said. Some efforts require long-term investments, such as in individual and corporate tax models, and even then one often has to change traditional ways of doing things. Before 1984, tax changes were distributed by adjusted gross income (AGI), which meant that the fictitious negative partnership income of tax shelters was subtracted from AGI in a way that made many rich look poor and tax shelter reform look like an attack on the poor. This had to be amended. Many of these efforts take months or years to develop.
  8. Empower well the plumbers, architects, and engineers—your crew in the Treasury’s Office of Tax Policy and the Congressional Joint Committee on Taxation—if you want a structure that will stand. They often know what pipes can or need to be welded together, but they only do what they are empowered to do in a world where a lot of people make crazy claims. For some reason, smart doctors, lawyers, and entrepreneurs when elected or appointed to political positions think that they have miraculously garnered the talent to weld together the pipes through which explosive gas flows.

Want to predict the probability of reform? Simply go through the list and ask yourself the extent to which those in charge at any stage understand and have a plan for dealing with these types of issues.


2 Comments on “How to Design Tax Reform: 8 Lessons from 1986”

  1. Michael_Binder says:

    The times are not that different. We have week growth and a President who repeats the oft-heard lie that tax cuts are good for the economy. This time, however, we have three instances where we know rate cuts led to financial debacles: 86 led to the S&L crisis (although GRH helped create the recession that defeated GHWB), the capital gains cuts that fueled the tech boom and bust and the Bush cuts that led to anemic growth for workers, too much for the rich and the 2008 crash. Let’s not be fooled again.

    Trump wants giveaways, not reform. If he had half a brain I would suspect he had an angle that would make him richer because of a recession.

    The princples I would set out are most people not having to file and higher taxes on the wealthy to pay down the debt so the coming interest financing crisis never occurs. I am sure Trump wants the oppossite, solidarity in filing and empowering the job creators (sadly, his idea of a job creator and mine are different. Consumers are job creators).

    I hope the usual consensus is dead. Broadening the base to lower rates simply results in more incentives for CEOs to cut payroll. Never again.

    The way to calculate who pays the bill is to determine who owes the debt. Is it per capita? Is it owed by entitlement beneficiaries? (Either would give it Junk Bond status) Or is it owed based on income taxes paid? If the latter, someone who pays $100,000 in tax owes $1,050,000, based on the total debt (government funds are eventually repaid with taxes) divided by income taxes collected. Driving that point home makes it obvious who tax reform should ding more and why they would want to pay more now.

    Tax reform should have an effect on health and education clients paid through the tax code. Their benefits should come through an employer-paid Subtraction VAT, which is by far the easiest way to administer them.

    If the 15% or 20% pass through passes, the old tax shelters will be back with a vengence.

    Using OTP and JTC would be wise, unless you are selling a pig in a poke, which is likely this time.

  2. David Flynn says:

    Great stuff!

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