The story behind the story is that “tax reform,” as we know it, is dying. During the 1980s, no major piece of legislation better symbolized bipartisan consensus than the Tax Reform Act of 1986, which was regarded by both liberal and conservative experts as the best tax law since World War II. The basic idea was simple: Reduce tax rates and recover lost revenue by ending (or limiting) tax breaks. The struggle between President Obama and House Speaker John Boehner over the “fiscal cliff” indicates that this beneficial consensus has collapsed.
Just the opposite is occurring. President Obama insists not only that the rich pay more in taxes (a legitimate demand) but also that their tax rates go up (questionable). This turns traditional tax “reform” on its head. Boehner says the added revenues should come through closing loopholes. The two also disagree on the amount of tax increases: Boehner has offered $800 billion over a decade, about half of what Obama wants. But this difference is amendable to negotiation; the rates-versus-loopholes dispute is less so.
For Obama, the obsession with raising top rates (from today’s 33 percent and 35 percent to 36 percent and 39.6 percent) seems an exercise in political symbolism. He wants to be seen as vanquishing the rich — and Republicans. Otherwise, why not accept Boehner’s means (loophole closing) to achieve his policy ends (higher taxes on the rich)?
The White House claims that loophole closing can’t raise enough revenues. This is bogus. The nonpartisan Tax Policy Center has estimated that capping all itemized deductions at $17,000 for couples and $8,500 for singles would produce $1.7 trillion in added taxes over a decade. To be sure, there would be practical problems; some tax increases would fall on households under Obama’s income thresholds of $250,000 for couples and $200,000 for singles. But these could be managed with adequate political will.
Unfortunately, it’s missing. The itemized deductions most threatened would include those for charitable contributions, interest on home mortgages and state and local taxes. Howls would come from affected groups: churches, universities, hospitals (the charitable deduction); builders, real estate brokers and mortgage bankers (the mortgage interest deduction); and state and local governments (the tax deduction). Obama seems unwilling to spend his political capital opposing these groups.
The lower rates and broadened tax base of the 1986 law had explicit goals: to increase economic growth; to reduce the use of taxes to promote some activities and discourage others; to minimize lobbying for tax breaks; and to make the system simpler. With time, the appeal of these goals has faded.
Economists generally believe that taxes influence behavior and that low tax rates favor growth while high tax rates discourage it. But the overall effects are hard to measure and may be small. Several recent reports from the Congressional Research Service could find no clear relationship between changes in tax rates and economic growth rates. This is probably true, because other forces affecting the economy often overshadow the impact of taxes, for better or worse.
In the 1950s, tax rates were high but so was economic growth. The post-World War II boom, driven by pent-up demand in consumer goods and housing, dwarfed any ill effects from taxes. Asked about gains from the 1986 law, a group of economists guessed that it might have ultimately increased the economy’s annual growth rate by one percentage point, if “allowed to remain in force.” This would have been a sizeable gain, but the effect would have been gradual and invisible.
That’s not much of an advertisement.
As important, many politicians support tax breaks for favored groups (the elderly, the poor, small business) and causes (homeownership, attending college, “green” industries). This enhances their power. The man who really pronounced the death sentence for the Tax Reform Act of 1986 was Bill Clinton, who increased the top rate to 39.6 percent rather than broadening the base. As the top rate rose, so did the value of generating new tax breaks. Ironically, many of the people who complain the loudest about Washington influence-peddling and lobbying are the same people who support higher tax rates, which stimulate more influence-peddling and lobbying.
After the 1986 law, the top statutory rate was 28 percent and rates were the same on ordinary income and capital gains (profits on the sale of stocks and other assets). The preference for capital gains — they’re now taxed at no more than 15 percent and represent the biggest tax break for the wealthy — was reinstated only after the top rate rose. The 1986 law was better than what we have today and, almost certainly, better than what we will have tomorrow. It depended on bipartisan support and White House leadership. There is now little of either.
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