Warring Republicans and Democrats on Capitol Hill have little hope of drafting an ambitious plan to tame the national debt by Thanksgiving unless they can agree on an approach to rewriting the tax code, key lawmakers and leadership aides say.
But any attempt at a tax overhaul would require policymakers to clear some daunting hurdles, including an old battle over a fundamental question: Do tax cuts pay for themselves by spurring economic growth?
The answer could be pivotal to breaking the partisan deadlock over the debt that has bedeviled Washington for months. Republicans have said they cannot support any increase in tax collections except through economic growth. And Democrats have said they cannot support additional cuts in spending except as part of a package that includes new taxes.
As a bipartisan supercommittee struggles to slice borrowing by at least $1.2 trillion over the next decade, some Republicans say an agreement to count revenue generated by economic growth — a process known as “dynamic scoring” — could be the magic elixir that greases the skids to a more far-reaching compromise.
“Smart tax reform will result in more economic activity. And additional economic activity will generate more revenue — not by raising taxes but by generating economic growth, which is what both parties want to see,” said Sen. Rob Portman (R-Ohio), a supercommittee member who is urging his colleagues to aim higher than the $1.5 trillion goal.
Some Democrats appear inclined to listen. On Thursday, as the committee probed the issue of taxes in its latest public hearing, Sen. John F. Kerry (D-Mass.) said he wanted to “second powerfully what Senator Portman said about our opportunity here.”
Given the committee’s vast powers to shape legislation and push it through Congress, Kerry urged his colleagues to “try to get to that sweet spot” where a simpler and more efficient tax code “will drive our economy, that therefore will raise revenues and help us create jobs and deal with the deficit at the same time.”
But “dynamic scoring” is a pair of dirty words among many Democrats, who remember Republican efforts during the George W. Bush administration to use it to estimate the cost of tax cuts.
“Tax cuts paying for themselves became a staple of the Republican mantra that allowed us to cut taxes and invade two countries,” said Rep. Richard E. Neal (D-Mass.), a senior member of the tax-writing House Ways and Means Committee.
Senate Budget Committee Chairman Kent Conrad (D-N.D.) called dynamic scoring “too uncertain and too open to manipulation” by those who “just want to make believe they are solving the problem.”
While a dynamic score may provide valuable insights, Conrad said, lawmakers should not rely on the hope of economic growth to do the hard work of genuine budget cutting.
“I don’t think you can just make stuff up and think that that’s going to work,” he said.
The notion that tax cuts pay for themselves was first popularized by Ronald Reagan using the famous Laffer Curve. The idea has since been discredited by economists, including most conservatives in the field.
This week, in testimony before the House Ways and Means Committee, Douglas Holtz-Eakin, the former Congressional Budget Office director who tried to implement dynamic scoring, was asked whether he thinks tax cuts pay for themselves. Holtz-Eakin, who served as senior economic adviser to the 2008 presidential campaign of Sen. John McCain (R-Ariz.), answered simply, “No.”
But Holtz-Eakin said economic models have improved since his days at the CBO, making it easier to assess what effects changes in tax policy do have on the economy. Douglas Elmendorf, the current CBO director, last week agreed under questioning by Sen. Patrick J. Toomey (R-Pa.), a supercommittee member, that wiping out special deductions in the tax code and using the savings to lower tax rates for everyone could “enhance revenues to the government” without explicitly raising taxes.
Elmendorf cautioned that “the magnitude of that effect, of course, depends on the specifics of the policies that would be enacted.” The CBO has found that the effect may be quite small.
In a recent analysis of a generic plan that would reduce deficits by $2 trillion over the next decade under traditional methods of cost analysis, the CBO found that such legislation could actually reduce borrowing by an additional $600 billion, in part because lowering the deficit would improve the economy. But most of the extra savings came from lower interest costs on the debt. A stronger economy added just $200 billion through higher tax collections and lower spending on social safety-net programs.
“There’s not a lot of revenue, not as much as some would like to assume and hope for,” said Senate Finance Committee Chairman Max Baucus (D-Mont.).
And not all tax changes are good for the economy, Thomas Barthold, chief of staff of the congressional Joint Committee on Taxation, told the supercommittee Thursday. For example, lowering corporate tax rates by eliminating the biggest corporate tax break — accelerated depreciation — “is probably not going to be pro-growth,” Barthold said. “It’s probably going to be much more neutral.”
That could be bad news for those pushing the supercommittee to look at a tax code overhaul. Senior aides said the committee is far more likely to tackle the corporate code than the sprawling code for individuals. Work on the corporate code is further along, they said, and both parties agree that corporate changes should be aimed at lowering the 35 percent rate, not reducing budget deficits.
But the agreement tends to end there. And key Republicans reject the idea of rewriting the corporate code without also doing something to benefit the millions of business owners who report profits on their individual returns, a position that leads right back into the quagmire of the individual code.
Longtime tax lobbyists laugh at the idea that the supercommittee could make complicated tax decisions by the Nov. 23 deadline. Without a tax overhaul, senior aides in both parties say, the supercommittee is likely to cobble together a narrow package of spending cuts, war savings and tax loophole closures that leaves the big questions about taxes and entitlement programs for the 2012 campaign.
“If they get to $1.5 trillion,” said a GOP leadership aide, “that would be gigantic in this Congress.”