Tax Reform: No Magic Bullet for Fiscal Crisis
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The Fiscal Times
April 26, 2011

Every deficit reduction plan includes tax reform as a key ingredient of the plan. Who are we kidding?

In the old joke, a physicist, a chemist and an economist are stranded with no food or tools on a desert island. A can of tuna fish washes ashore. “Let’s find a rock so we can smash it open,” says the physicist. “Let’s build a fire, heat up the can, and blow the lid off,” says the chemist. They look at the economist. “Let’s assume a can opener,” he says.

At the moment there are four serious deficit reduction plans in circulation — one each from the President’s Commission on Fiscal Responsibilitythe Bipartisan Policy Committee,  the House Budget Committee Chair Paul Ryan, and the president himself — and all four assume a can opener. And not just any can opener, but rather a job-creating, revenue-raising, shared sacrifice bipartisan grand compromise of a can opener. It’s called tax reform. As a tool of fiscal balance it is economically brilliant and politically deft. But if we pin our deficit-reduction hopes on it, we’ll be making a big mistake.

The current tax code wastes resources,
distorts business decisions and leaves law-abiding
taxpayers feeling that they’ve been played for suckers.

I say that reluctantly. We all know the current tax code is a mess and needs to be overhauled. It wastes resources, distorts business decisions and leaves law-abiding taxpayers feeling that they’ve been played for suckers. The tax reform outlined (in varying amounts of detail) in all four deficit plans would eliminate tax loopholes and lower tax rates. In one stroke, that could make taxes simpler, fairer and less of an economic burden.

Better yet, tax reform lights a path for political compromise that could make serious deficit control possible. Think about it:

  • Passing a reform bill that lowered tax rates would let Republicans say they had cut taxes, even if the overall effect, after factoring in the broader tax base, would be to raise revenues as a percentage of GDP.
  • A reform that broadened the tax base would allow Dems to surrender middle-class tax breaks such as the deductions for employer-provided health insurance and mortgage interest — by pointing out that everyone is suffering equally.
  • That today’s tax code is a disgrace is something both sides already agree on. In today’s polarized Congress, that counts as a good place to start.

Most encouraging of all, Congress has pulled off tax reform once before in living memory. The Tax Reform Act of 1986 followed the same base-broadening, rate-reducing model being embraced today. We know it can be done.

Or do we? The experience of 1986 may actually explain why we can’t afford to look at tax reform as a silver bullet, appealing as it may be. We don’t have time. 

The 1986 reform was years in the making, even though it was easier to pull off than a similar reform would be today. Then, as now, Congress was split (Republicans controlled the Senate, Dems the House), but the partisanship wasn’t nearly so poisonous as today. “You had [House Ways and Means chairman and old-line Dem] Dan Rostenkowski working with an arch-conservative President. You had [Senate Finance chairman] Bob Packwood working with the junior Senator from New Jersey, Bill Bradley,” recalls Len Berman, professor at the Syracuse University Center for Policy Research. “Things were much less polarized.”

Tax reform is a great idea for many reasons, but it’s a
pretty oblique way to correct our fiscal course.

Moreover, when Congress launches an effort as ambitious as tax reform, it’s never clear where it will come out. The reform of 1986, for example, while it vastly improved the loophole-riddled law of the time, was only a partial victory for reformers. “The most politically vulnerable tax deductions were eliminated but the deductions with the strongest and most vehement political support (and economic cost) were retained,” writes George Mason University senior research fellow Jason Fichtner in a white paper for the Mercatus Project. “The exclusion of employer-­provided medical benefits and the home-mortgage interest deduction remained.” If that were to happen today, those two breaks would reduce tax revenue over the next four years by $1.7 trillion, according to the President’s budget projections.

There’s no reason to think that any tax reform we’d achieve now would be purer than the 1986 version.  So if 1986 is any guide, we could labor mightily to produce a tax compromise and still give birth to a mouse of a deficit reduction.

Even if that didn’t happen, it will be hard to explain to voters why Congress chose to tackle the tax code instead of directly attacking the budget deficit. One of Obama’s worst missteps—for which he was roundly punished in the 2010 election—was to appear focused on health care reform rather than what voters considered the most pressing issue, the economy. Today, voters are worried about the deficit, and they could view an exhausting battle over tax reform as a costly distraction.

If they did, they’d have a point. Tax reform is a great idea for many reasons, but it’s a pretty oblique way to correct our fiscal course. Yes, we might produce a bipartisan miracle that gives both parties the cover needed to do the right fiscal thing. We’re just as likely to spend years in political trench warfare that produces a wiser tax code but leaves the nation trillions of dollars deeper in debt with no roadmap to fiscal balance.  “It’s a lot of political pain to take when you’re not addressing the main issue,”   says Eric Toder an economist and tax expert at the Urban Institute.

We need a new tax code, no doubt about it. But first we need a plan to head off our impending fiscal disaster.  Any such plan would undoubtedly be more elegant if tax reform were part of it. But unfortunately, we can’t just assume tax reform into existence. We need to address first things first.

Eric Schurenberg
is editor-in-chief of BNET and CBS MoneyWatch.com. Previously, he was managing editor of Money and deputy editor of Business 2.0. Schurenberg was also managing editor of goldman.com, a site for Goldman Sachs Group's personal wealth management business.