Taxes are on everyone's mind again, even though April 15 is long past. We hear talk of tax caps, fair taxes, energy taxes, surtaxes, you name it. It is no wonder that the public is confused and finds it difficult to perceive a coherent view of national tax policy. Even when our budget debate has largely collapsed into a debate over taxes, few of the options being suggested demonstrate concern for maintaining a consistent and predictable tax structure.
The Tax Burden: Consider the size of the federal tax burden. Under the administration's 1983 budget projections, assuming continuation of current law and moderate economic growth, revenues to the national government are expected to average about 18.7 percent of GNP over the next five years. That figure can be expected to rise somewhat if we have a more robust recovery, as now appears likely. But in any event it is consistent with the average of 18.9 percent of GNP that revenues represented between 1963 and 1980, including all of the Vietnam War years. But with federal spending running at about 25 percent of GNP under current law, it is clear that either spending is too high or the tax burden is too low--and I don't believe the latter. In my view, whatever the nation pays in taxes, the real question will always be whether the tax burden is equitably distributed.
Even though economic growth will help bridge the gap between spending and revenues in the years ahead, few forecasters are bold enough to project that growth alone will bring the deficit within the 2 or 3 percent of GNP range that most economists think is consistent with sustaining a strong recovery. So we are likely to need major adjustments on both sides of the ledger if we want to keep recovery on track. The question inevitably is: if further tax changes are needed--in conjunction with a serious effort to restrain spending--what kinds of changes should they be? What should they tell us about the direction tax policy ought to take?
The Options: If we take the present tax structure as our starting point, the options are fairly clear. We can return to raising tax rates on individuals, permanently, or selectively, as in the so-called "third-year cap" proposal. We can resort to miscellaneous excise taxes of various sorts, whether on alcohol, tobacco, gasoline or other products. As a corollary to the excise idea, we can look into the energy area, as has often been suggested, to try to formulate an energy tax or import fee. Or we can continue the painstaking examination we began last year of existing tax preferences and benefits and of gaps in our voluntary compliance system. Unless we are ready to resort to a major new revenue source, such as a surtax, value-added or national sales tax, our options are fairly limited.
To make the right choice, we need to follow two basic principles: 1) we ought not to turn to new or add-on taxes so long as we have an income tax base that resembles Swiss cheese-- full of holes (some would say loopholes). It is simply unfair to raise tax rates when so many special tax breaks undermine the tax base and encourage inefficient allocation of resources; and 2) tax changes ought to be selected for their own merits in terms of public policy, rather than just random revenue sources. We must justify any revenue increase in terms of sound public policy, whether it be greater economic efficiency or more equitable treatment of taxpayers.
The Keys: Tax Compliance and Reform: There is only one good strategy for generating new revenues that satisfies both of these principles. That is, first, to continue to go through the tax code, simplifying and sorting out deadwood, and, second, to improve compliance with existing tax laws.
Political resistance to such an approach has been and will continue to be strong. Of course, Congress learned this year, in dealing with withholding on interest and dividend income, that tax reform is sometimes in the eye of the beholder and that sincere efforts to close the ever-widening tax compliance gap can be detoured by well-oiled lobby machines.
Partisan distractions such as the third-year tax cap, or attacks on the indexing provision that guarantees equity for working people, are major obstacles to progress. Indexing is, in fact, the key to tax reform, because it forces scrutiny of the existing tax code and of the profusion of special breaks that we used to finance with bracket creep.
Therefore, we need a strong bipartisan effort if we are still serious about tax reform and economic efficiency.
Because, believe me, the compliance problem isn't about to go away. When noncompliance costs the Treasury $100 billion, as estimated for the current year, it is time to agree on a program of action. When the compliance gap is predicted to hit the $150 billion mark by 1985, the need for action becomes acute. And we haven't even yet mentioned the tab for "tax preferences."
Even though the country faces mammoth budget deficits, the Finance Committee is daily referred dozens of new tax bills calling for tax cuts to promote a vast array of worthy objectives. If we enacted all of these pending "tax break" bills, the revenue loss would undoubtedly run into the tens of billions. We need to stop and examine tax preferences that already exist before we add new ones.
Just this year alone, these tax preferences are estimated to be $296 billion, and, you guessed it, it's going to be a lot more next year.
The Challenge: We cannot wave a magic wand and wake up with a new tax system that meets all our needs. We cannot ignore, for better or worse, the legitimate interests of those who have a stake in the present tax laws. That means we have to continue to work step by step to improve the income tax, facilitating further rate reductions as we progress.
Those who advocate fair taxation and coherent tax policy owe it to themselves, and to the public, to vote for the legislative measures that achieve real progress toward lower rates and a more comprehensive tax base.
Last year's tax bill, the Tax Equity and Fiscal Responsibility Act, was a bold first step in making the tax code more fair, but it certainly did not exhaust the list of changes that can or should be made. Let me address just a few areas. For example, we need to put the brakes on the growing practice of leasing property used by federal, state and local governments and by tax-exempt organizations. This scheme allows wealthy investors to claim the tax benefits from property such as Navy ships, city halls and college campuses and offer the charity or governmental unit backdoor federal funding beyond the amount specifically appropriated. Similarly, we need to be closely examining the corporate tax rules that allowed a U.S. company to transfer much of its operations to a Panamanian subsidiary, thereby saving $220 million in federal taxes, according to the company's own estimates.
The taxation of fringe benefits is another area that needs review. Not only do we need to make certain the tax base is not being unduly eroded, but we need to establish some certain rules to guide bewildered taxpayers. The administration has proposed that one variety of tax-exempt fringe benefit--employer-paid medical insurance --be limited to $175 per month for a family plan. This cap would raise an estimated $2.3 billion next year, and advocates point to possible benefits of the proposal in controlling health-care costs. Nevertheless, this and any other proposal affecting fringe benefits will be hotly controversial.
In the area of increasing tax compliance, we need to provide the IRS with better tools to collect taxes from the illegal sector. Specifically we should seriously examine stronger reporting of currency transactions and perhaps a recall of all $100 bills. Already we have a provision in the Caribbean Basin Initiative designed to gain IRS access to secret bank accounts in Caribbean countries.
It is easy to set forth grand schemes and vote for taxes in an abstract budget resolution, but it is more difficult to execute the strategic steps needed to reform our tax system. The challenge for both parties in Congress will be to match their rhetoric on tax reform and improved compliance with real performance.