Almost everyone favors “tax reform” in the abstract: Broaden the tax base by reducing deductions, credits and other tax breaks, and then cut top tax rates. But this sort of sweeping tax reform is usually a political nonstarter, and if you want to understand why, take a look at the tax proposals in President Obama’s State of the Union address.
His recommendations include: a new corporate tax credit to subsidize moving jobs from abroad back to the United States; a tax credit for companies locating in communities that were “hit hard when a factory left town”; extension of “temporary” tax credits to promote U.S.-produced windmills and solar panels.
These are precisely the special breaks that complicate the tax code and push up top rates. Manipulating taxes to favor or disfavor particular industries, groups or regions is a source of power that Democrats and Republicans alike are loath to surrender. That’s why major tax reform fails, despite routine endorsements from both parties.
Yes, Obama does this, too. The administration pledges to “simplify the tax code and close loopholes,” says a White House fact sheet.
The inconsistencies inspire no sense of embarrassment. The president wants to be for “reform” without sacrificing the chance to brag that he’s doing good things: for example, inducing companies to “in-source” jobs from abroad and resisting the relocation of jobs overseas. In practice, his proposed tax breaks may be too small to have much effect. All they would do is further complicate the tax code.
Take the “manufacturing communities tax credit.” It would benefit companies investing in communities “when a military base closes or a major employer closes or substantially reduces a facility or operating unit, resulting in a permanent mass layoff.” But how would this be defined? Would it be a fixed number (say, 1,000) or a share of the local labor force (say, 5 percent)? Could companies already in a location receive the credit if they simply expanded? By how much?
“It just invites lobbying [over detailed language],” says Gary Hufbauer of the Peterson Institute, a tax expert and former top Treasury official. “These proposals are a gift to K Street. They won’t lead to reform.”
Another critic is economist Bruce Bartlett, author of “The Benefit and the Burden: Tax Reform — Why We Need It and What It Will Take.” Bartlett’s book is a clear and comprehensive overview of today’s complicated tax system. Reform’s main purpose, he argues, is to minimize how much taxes distort behavior.
“Let businesses and families make economic decisions without being biased or even pressured to do one thing rather than another, such as buy rather than rent a home, just because the tax system makes it worthwhile,” he writes.
By contrast, many politicians view the tax code as a tool to reward or punish various constituencies and causes. “It’s a mistake [for Obama] to put more gimmicks in the tax code,” says Bartlett. “If he puts more in, he lacks credibility . . . if we want tax reform.” Of course, Republicans are no less hypocritical. Their various “reform” proposals consist of steep rate cuts, without paying for them by ending tax breaks. The result would be huge increases in government deficits.
Altogether, the prognosis for genuine tax reform is poor. The Tax Reform Act of 1986, which ended many tax breaks and lowered the top individual rate from 50 percent to 28 percent, seems an anomaly. It enjoyed strong support from President Reagan and some powerful congressional Democrats.
But President Clinton undermined the logic of tax reform by pushing through an increase in the top individual rate to 39.6 percent. As rates climbed, new tax breaks proliferated. In 1997, Republicans in Congress acted to cut the top rate on capital gains (profits on the sale of stocks or other assets) to 20 percent; it was later cut to 15 percent. Other new tax breaks included the child tax credit and Roth individual retirement accounts.
It’s easy to imagine a better income tax. The top rate would be no higher than 30 percent. There would be no special rate for capital gains. Most tax breaks, including the deductions for mortgage interest and charitable contributions, would be eliminated or reduced. Don’t hold your breath. Tax simplicity sounds good, but — politically — complexity wins hands down.