Tax Reform R.I.P.
By Robert J. Samuelson
Wednesday, May 12, 2004; Page A23
Eugene Steuerle is one of Washington's ranking policy wonks -- a term used here with respect. He's forgotten more about taxes in the past 15 seconds than most of us will ever know. He arrived in Washington in 1974, worked for years at the Treasury and moved in 1989 to the Urban Institute, a think tank. Steuerle has just written a book, "Contemporary U.S. Tax Policy," that addresses the insistent question: Why is the federal tax system such a mess? The answer, in a word, is democracy.
In theory, it's easy to imagine a simple tax system with low rates, a broad tax base -- the amount of taxable income -- and substantial "progressivity," meaning that the rich pay higher rates. But in practice it has been elusive. Democrats and Republicans alike are too eager to use tax breaks to advance various social, economic and political agendas. The resulting tax code is so confusing, complex and contradictory that it costs taxpayers (in accounting fees and the value of their time) about $100 billion annually to complete their returns, estimates economist Joel Slemrod of the University of Michigan. In 2003 that roughly equaled the combined spending of the departments of education ($57.4 billion), homeland security ($32 billion) and state ($9.3 billion).
The appeal of tax breaks is that they give "the appearance of reducing the government's size . . . even as government interference in the economy increases," writes Steuerle. But a tax system that promotes various causes (more saving, more health insurance, college attendance) cannot be simple. It brims with provisions. Goals conflict; contradictions are unavoidable. Similarly, a system that favors some taxpayers (homeowners, the elderly) must disfavor others. "Fairness" suffers.
Of course, the rich often try to skirt taxes through abusive shelters. But it's a myth that legal tax breaks mainly benefit the wealthy. The government publishes a yearly list of "tax expenditures," indicating the costs in forgone taxes of different breaks. These favor the middle and upper-middle classes. Here are some of the biggest for 2004: tax-free employer contributions to pensions and 401(k) plans, $123 billion; tax-free employer payments for health insurance, $120 billion; the deductibility of interest on home mortgages, $68 billion; charitable deductions, $43 billion; the exclusion of some Social Security benefits from income taxes, $27 billion. For the wealthy, the biggest break involves preferences for capital gains (mainly profits on stocks); in 2004, they're worth $82 billion.
All these tax breaks are immensely popular. They would be more defensible if they always made economic sense. Unfortunately, they don't. One reason Americans are building ever-larger homes for ever-smaller families is that housing is subsidized through the tax code. Similarly, the tax code subsidizes health insurance and, by shielding covered patients from many routine costs, promotes higher health spending. "The United States should have a tax system which looks like someone designed it on purpose," the late William E. Simon, Treasury secretary from 1974 to 1977, once said. Dream on.
Actually, Congress and President Reagan once made a stab at a better system. The Tax Reform Act of 1986 reduced tax rates and broadened the tax base. But the new system could survive only if politicians exercised self-restraint. It wasn't to be. Bill Clinton raised tax rates and expanded tax breaks. President Bush has gone one better. He's lowered rates and expanded preferences.
Sometimes this ceaseless competition for new tax breaks implodes. Congress is now considering a bill to repeal a provision of the corporate tax that, because it violates international trade rules, is subjecting $4 billion of U.S. exports to European tariffs. But the House and Senate versions of the bill are so stuffed with conflicting tax breaks (including ones for cruise ships, ranchers and oil companies) that the legislation has stalled.
As Steuerle notes, taxes cannot be divorced from broader budget questions. What should government do? For whom? Who pays? How much might new taxes hurt economic growth? But this is a debate we resolutely avoid. Republicans and Democrats merely echo their supporters' fondest hopes. Republicans reject any tax increases -- ever. Democrats indicate that taxes need rise only on the wealthy. Considering existing budget deficits and future spending commitments, especially for retiring baby boomers, neither message is realistic.
Well, that's democracy. Tell 'em what they want to hear, not what they need to hear. Steuerle suggests that budgetary pressures -- including more taxpayers triggering the alternative minimum tax -- will promote sober solutions. "The grand budget compromise that must take place," he writes, "is between those who would allow retirement and health programs to continue to grow without bound and those who would continually prescribe tax cuts into the future." Based on history, that seems a triumph of hope over experience.
© 2004 The Washington Post Company