Whatever the defects of the Reagan administration's original tax proposals, they had the virtue of simplicity. This is a virtue rapidly being compromised by Congress in its zeal to provide more favorable incentive for certain kinds of behavior and more favorable treatment to certain kinds of taxpayers. Many of the refinements being offered seek to make good on the rather weak claims of the administration for the stimulative effects of its proposals on work and saving. Others are being drawn from the standard stock of preferential gimmicks rolled out every time tax "reform" is on the agenda. If the tax debate drags on very long, we should also see exemptions, deductions and credits being tacked on at the behest of various groups that, having lost out on the spending side of the budget, will be scrambling to recoup on the tax side.
This is bad business, and not just because it undermines the budget-cutting effort to reduce deficits. It's also a very inefficient way to encourage almost anything you can think of except tax evasion. One reason is that, unless you are trying to encourage some type of behavior that almost no one would otherwise engage in, most of the tax breaks go to pay for something that would have happened anyway. For example, most investment tax credits go to companies that would hve made the investment without them. The same is true of tax breaks to encourage hiring workers, saving, charitable giving or buying American cars. Most workers do find jobs, most people at all taxable income levels save some money and give to charity, and Detroit still manages to sell several million cars every year.
If the tax subsidy pays for a particular kind of service -- educational, social or artistic -- there is a good chance that, without the discipline of the profit motive, the service will be poorly managed. If you're dubious about the efficiency of social programs subject to direct government monitoring, imagine what they would generally be like with no review. And, of course, the very real possibility exists that the tax break won't buy anything at all. The Internal Revenue Service doesn't like to talk about cheating, but estimates of tax cheating dwarf the known losses from the much-talked-about fraud, waste and abuse in federal social programs. When it's a question of adding special deductions or credits for the more than two-thirds of individual taxpayers who now take the standard deduction and have very low probabilities of audit, it is realistic to assume a great deal of the benefits will go to cheaters.This not only greatly reduces the effectiveness of whatever incentive is being promoted, but also gives a nasty cast to the whole enterprise.
In a rapidly changing economy, tax incentives also become quickly outmoded. Since they are virtually impossible to repeal -- there is nothing so zealous as the guardian of a tax gimmick -- they soon impede, rather than aid, sound choices by businesses and individuals. The simple truth, long expounded by most tax economists, is that the fairest and most efficient tax system is one that doesn't try to encourage anything at all. A totally unobtrusive tax system can't be designed, but there is clearly enormous opportunity for streamlining the Victorian gingerbread horror that our tax system has become.
Special tax breaks for everything from day care to interest on debts -- now add up to about one-quarter trillion dollars a year -- more than is spent on defense, or Social Security. Each of these loopholes is, of course, treasured by some among us who see it as our own little bonus. We would all, of course, like to have lower taxes, but we doubt that we'd make out as well if all the preferences were cashed in and the proceeds used for general tax reduction.
Of course this isn't true for most people. If all the exemptions, deductions and credits were eliminted, it would be possible to institute such a massive reduction in tax rates that most taxpayers would be substantially better off, and even those who weren't would find themselves with a new freedom to buy or invest in what they really wanted rather than what their tax accountant advised. For example, Harold Beebout, an economist at Mathematica Policy Research, Inc., recently estimated that if everyone were allowed a personal exemption large enough to ensure that no one in poverty paid taxes at all (this would be an exemption of about $8,500 for a family of four), and if all other exclusions were abolished, the same revenue now raised could be gotten from a flat income tax rate of about 22 percent on income above the exemption. If a modest amount of progressivity were introduced, initial tax rates could be still lower.
The result would be a marvelously simplified, ultimately fairer and far more efficient tax code. Gone would be the penaltie for second earners or single individuals, the incentives for credit buying or speculation, the subsidies for high-flying consumptin disguised as investment. People could buy, save and work as their unfettered preferences and the incentives of the marketplace suggested. This sort of reform, with similar simplification and reduction of corporate tax rates, would provide a surer stimulus to stable economic growth than any newly minted set of tax preferences, however cleverly devised.
Simplicity is so foreign a concept to the American political tradition on either the tax or spending side that moves in that direction are rarely considered. This is a good time to remind ourselves, however, that the deal lies in that direction, not in moves toward greater complexity. Unfortunately it appears that a once-in-a-lifetime opportunity is being missed to buy out some of the worst pervrsities and inequities of the tax code with the very substantial tax cuts now being offered, especially in the upper tax brackets where most tax preferences roost. Worse yet, new burdens may be added for the tax reformers of a future era.