Tax Reform: Obama is Walking into the Neutrality Trap
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The Fiscal Times
January 28, 2011

In his State of the Union address, President Obama called on Congress to enact tax reform. Republicans all applauded because to them tax reform is just another excuse to cut taxes. However, their response was muted when he said that any tax reform legislation must be paid for by getting rid of loopholes and cutting spending through the tax code.

No one denies that there are many aspects of the tax code desperately in need of reform. The problem is that Republicans refuse to talk about anything except further cutting tax rates. But the idea of tax reform has always meant much more than that. It also means getting rid of tax preferences that bias individual and business behavior in ways that may not be optimal for them or the economy. In other cases, tax preferences simply waste money subsidizing people and businesses for no reason except that they belong to some politically favored group.

A key goal of tax reform must be to rid the tax code of unjustified tax preferences. The goal, which Republicans used to believe in, should be to achieve tax neutrality. This basically means that people and businesses should make economic decisions based solely on the economics and not because the tax system in effect subsidizes them to do one thing rather than another.

Perhaps the best example is the exclusion for employer-provided health insurance. This is clearly part of workers’ compensation, but they pay no taxes on it, while their employers are still allowed to deduct the cost. This makes $1 of health insurance far more valuable than $1 of cash wages, which is a key reason why health costs have risen so much; workers treat health care like something that’s essentially free.

Once upon a time, long ago – 2008 to be exact – Republicans like Sen. John McCain actually campaigned on getting rid of the health insurance exclusion as an essential element of health care reform. He argued, quite correctly, that there is little hope of getting health care costs under control unless the demand for it is reduced. The best way of doing so is by encouraging people to be more cost-conscious, which they would be if they paid health costs out of their own pockets. If the revenue now being lost to the health insurance exclusion were instead used to fund expanded Health Savings Accounts – a sort of Individual Retirement Account from which health costs can be paid – then workers would benefit financially from reducing their own health care spending.

Unfortunately, this sensible proposal got deep-sixed when Democrats initiated health care reform. Republicans quickly concluded that their political fortunes would be maximized by simply opposing whatever the Democrats were for without putting any alternative on the table. Those few Republicans who were willing to say that this was misguided, that Republicans had a responsibility to put forward legislation that embodied their vision of health reform, were completely ignored. One, David Frum, was fired by the Republican-leaning American Enterprise Institute for saying so publicly. Another, Senator Robert Bennett of Utah, was denied renomination by Republicans in his state because he co-sponsored a health reform bill with Sen. Ron Wyden, Democrat of Oregon.

Something similar is now happening with tax reform. Republicans claim they are for it, but they steadfastly refuse to name a single existing tax provision that is worth getting rid of; they are only for tax rate cuts and that is the sum total of their contribution to the tax reform debate. Their rationale, apparently, is that eliminating any tax loophole, no matter how egregious or unjustified, would constitute a tax increase; and they are against all tax increases, period.

The other factor in Republicans’ thinking is just cynical politics – they are for the sugar of rate cuts, but it is the sole responsibility of Democrats to come up with the medicine of actually reforming the tax code by proposing revenue offsets to pay for the rate cuts. Grover Norquist, president of Americans for Tax Reform and the man who, more than anyone else, lays down the Republican line on all tax issues, told me this when I asked him about coming up with offsets to pay for tax reform: “I recommend taking the corporate rate to 25 percent. The Dems can suggest tax hikes if they believe they need to ‘make up’ revenue. That is a bipartisan division of labor.”

The political trap is obvious. Any actual reform that would increase revenue will be relentlessly attacked by Republicans as a tax increase and they will quickly send out fundraising letters to whatever group or industry is affected, requesting campaign donations to prevent the Democrats from raising their taxes. No mention will be made by Republicans of the idea that the reforms would be coupled with tax rate reductions in a revenue-neutral manner that neither raises nor lowers net tax revenue in the aggregate. Unfortunately, this strategy will doom any hope of tax reform. No Democrat is going to put forward any revenue-raisers under these circumstances.

Bruce Bartlett’s columns focus on the intersection of politics and economics. The author of seven books, he worked in government for many years and was senior policy analyst in the Reagan White House.