Washington is surging on a wave of euphoria in the aftermath of the Senate Finance Committee's stunning tax reform success. From the ashes of a humiliating defeat, Chairman Bob Packwood and his committee came up with a dramatic and sweeping package that is almost universally being portrayed as a victory over a vast array of special interests. Senators are scrambling over one another to get on the side of the public interest in support of tax reform.
There are many good reasons for them to do so. A reduction in marginal rates is seen by nearly every economist and economic analyst as good for the economy, growth and productivity. Removing millions of low-income taxpayers from the tax rolls is the single most positive feature of the plan. And closing narrow loopholes and making every class of taxpayer pay a fair share is a goal we all share.
But before we get completely overcome basking in the euphoria and before we define the coming Senate debate strictly and narrowly in terms of the public interest vs. the special interests, we ought to pause to consider the down side of tax reform. There are tangible, real costs our society will pay.
Some of those costs are transition ones. The tax system of the United States, for better or worse, comes close to being incorporated into the genetic material of the American economy. It shapes housing availability and rental costs, tuition levels at public and private colleges, the price and availability of every good we consume. In other words, the tax system is the embodiment of the American status quo. Our political system is designed explicitly to prevent cataclysm in the status quo of the variety represented by the Packwood tax plan, unless there is a major crisis or an overwhelming consensus on the urgency for action. We have neither right now. If tax reform of this type actually gets enacted into law, it will be a unique experience in modern political life.
To imagine that such an upheaval would be without cost for any of us (except the "special interests") is wildly optimistic. Up to now, we have been defining the tax issues in terms of narrow "winners" and "losers" -- those who, in strict money terms, would pay lower or higher tax bills each year. But imagine the impact in broader terms.
Take the median-income taxpayer in the 40 percent bracket who gets a $300 lower annual tax bill. He's a winner -- right? But at some point this taxpayer, who has carried a $1,000-a-month mortgage based on the belief that his after-tax housing cost is $600 per month and who has paid a high property tax in part because his after-tax cost is only 60 percent of it, will likely realize that his calculation has changed. Suddenly, his after-tax mortgage cost is $730 a month, or $1,560 more per year -- much greater than his direct tax bonus. His property tax cost is higher, too -- and his house is probably worth less than before, because home buyers will make their calculations and offers based on their after-tax costs, now higher. That "winner" may consider himself a "loser" before long.
The same calculus may also hit the apartment renter, who doesn't have to worry about his mortgage interest being devalued, but may have his next rent increase blamed on a system that has jacked up the after-tax costs of his landlord by altering depreciation provisions, disallowing the landlord's interest deductions and removing low-income housing incentives from the code.
And both home owner and renter may see their children's college tuition bills rise as colleges find the devaluation of the charitable contribution and new rules regarding bequests and donations cut the share of their budgets coming from private contributions.
These taxpayers and millions of others may well find that a reformed tax system over the long run will benefit them and the country as a whole. But in the shorter term there will be cries of anguish -- and not all of them from "special interests."
There is a broader cost of sweeping tax reform that also needs to enter the debate. A government has three basic weapons to use to solve or cope with societal problems: government money, through programs; the tax system, through incentives; and regulation. Given the nature of the federal budget in the 1980s and the continued movement toward deregulation, sweeping tax reform means a unilateral disarmament on the part of the federal government when it comes to dealing with domestic issues and problems.
The discretionary component of the federal budget has been cut in half as a proportion of the budget in the past decade or so, and it continues to shrink. Regulation is the least effective and most unpopular route for government action. Dramatic tax reform strips the tax system of most of its powers for solving problems. That, of course, is one reason why we are moving toward reform -- we have accepted the economists' notion that the tax system ought simply to raise revenue in as neutral a fashion as possible and not be distorted into a process for shaping the economy or solving social ills.
But surveys make it abundantly clear that we as a people still want government actively involved in protecting the poor, cleaning up the environment, reforming the health system, improving public education and so on. The abrupt removal of the tax system from this arena will be wrenching. Charitable organizations, medical research, low-income housing, urban redevelopment -- all will take a direct hit from tax reform, at the same time that the other governmental avenues for protecting them and cushioning the blow are being narrowed or closed as well. Now is the time to think through what role we want the tax system to play -- and what role we want the government to take.
Tax reform is a highly desirable goal. If I had to choose between the existing tax system and the Packwood plan, I would choose Packwood. But it is not without its considerable public costs. If we do not allow the coming debate to focus on these broader issues, we may end up with tax reform -- but with a public gulled into believing that reform only hurts those horrible special interests. When the costs subsequently become clear, beware a surprised, enraged and disillusioned public.