If political rhetoric is a sign, tax reform is a hot topic as the 112th Congress tries to reduce the nation’s long-term debt and pass laws to help lift America out of the worst recession in decades.
Former Treasury tax officials appeared before the Senate Finance Committee Tuesday to begin the lengthy debate on reforming the tax system—both individual and corporate. “I’m optimistic that we will be in a position to rebuild the [tax] system in a way that meets President Reagan’s three criteria” of assessing the system’s fairness, efficiency, and complexity, said ranking member Orrin Hatch, R-Utah.
But real reform may not happen soon—especially when it comes to getting public acceptance of changes that might even cosmetically add to individuals’ taxes. “The difficulty [with tax reform] is the education of the American people,” Fred T. Goldberg, Jr., a former Treasury tax official said at the hearing. “You can come up with lots of systems that will get you where you want to go, which my guess is this committee would agree with, but how are you going to sell it to the American people? That’s the biggest challenge.”
Democrats and Republicans for years have said they want to overhaul the dense and loophole-ridden U.S. tax system, which hasn’t been revised since 1986, when Reagan was president. President Obama is helping the issue get attention both with his Fiscal Responsibility and Reform Commission, which called for elimination of $1.1 trillion in tax credits and exclusions to reduce the deficit, and with comments in his recent State of the Union saying he would support lowering the corporate rate to encourage investment and hiring as long as no revenue is lost in the process. But such a feat would likely require eliminating loopholes, special tax deductions, credits, and exclusions that many corporations have long relished.
The U.S. corporate tax rate is 35 percent, among the highest of any nation besides Japan (which will be lowering its rate this spring); U.S. companies say puts them at at a major competitive disadvantage. But with the deficit on pace to hit $1.5 trillion or more this year and overall debt projected to rise by $7 trillion over the next decade, options for recouping revenue while reducing the tax rate are increasingly scarce.
“Even though everyone’s talking a lot of happy talk about tax reform, which is sort of unusual, it’s not really a consensus view because everybody is talking about something different,” said Martin Sullivan, contributing editor at Tax Analysts, a nonprofit publisher of tax information. “The fiscal hawks foresee tax increases, the pro-competitive right foresees tax cuts, and the academics and economists tend to look at it as a revenue-neutral redo of 1986.”
Don’t expect much before the 2012 presidential election, Sullivan said. “If Obama gets reelected, he can start talking about tax increases but for now he can’t really go near the issue in any major way, and doesn’t,” said Sullivan. “In 2013, he won’t have the reluctance and therefore may provide real leadership on revenue-raising.”
Some say Congress could try to enact corporate tax reform before the 2012 election. “There’s a reasonable prospect of revenue-neutral corporate rate reduction—you can conceivably construct a bill that does that,” said John Buckley, former chief tax counsel to the House Ways and Means committee. “On the individual side, it’s much more difficult to do.” In fiscal 2008, 45 percent of federal tax revenue came from individual income taxes, compared with 12 percent from corporate income taxes, according to The Tax Policy Center.
But for revenue neutral corporate tax reform to be successful, a critical mass of business groups needs to be in favor of the package, which happened in 1986, Buckley said. “I’m not sure that could happen today.” Obama’s insistence that tax reform be revenue-neutral virtually dashes any possibility that the business community will be able to rally together behind it, Sullivan said. In theory, the idea of lowering the corporate rate has significant appeal, but in practice, its impact will vary in different sectors, he said. “With revenue-neutral reform, there will always be winners and losers, and that will blow apart the business coalition,” he said.
Some economists say one of the few remaining places to look for revenue is by adding a consumption tax, or a European-style Value-added tax, to our current tax system. But last year’s Senate vote on a VAT failed by a margin of 85-13—and those prospects are not apt to change any time soon.
“There is kind of a natural coalition against value-added taxes that won’t be going away any time soon,” Buckley said. “Republicans view it as a ticket to big government, and Democrats find it extremely regressive unless you input an elaborate system of rebates, which could become rather unwieldy.