It is an article of faith in national politics that the reform of the federal tax code is what’s standing between us and faster growth, higher productivity, better jobs, and whatever other good outcome you want to ascribe to this endeavor.
Well, riffing off of a) my own observations from decades in the trenches of this argument and b) this speech by President Obama’s chief economist Jason Furman, I disagree. Sure, there’s a lot of brush in the tax code that ought to be cleared out, some of which I’ll discuss in a moment. But these days, “tax reform” mostly means selling big, regressive tax cuts that will breed magic ponies by the herd. Instead of getting bogged down in an argument that has and will continue to lead nowhere, we’d be much better off to consider tweaks that fall far short of large-scale reform but could help—and have helped—in important ways.
The big tax reform ideas you hear about today come from the candidates for president, as they’re not bound by political constraints, or, in some cases, arithmetic. The Republicans typically want to cut trillions in taxes, largely benefiting the wealthy, and make up the revenue losses by…well, they typically don’t say how. Or, if they do, it’s the magic of “dynamic scoring,” growth effects that offset the losses. Regarding these scores, Josh Barro of the New York Times provides a public service in pointing out that in the wrong hands, “You can get essentially any answer you want out of a dynamic tax model by changing the assumptions about economic behavior that you plug into it. If you turn the dials far enough, you’ll get a report that shows a tax cut will pay for itself, even if it won’t.”
You want to know what tax cuts for the wealthy really do? They raise their after-tax income and lower government receipts, just as you always suspected. You think I’ve got a thumb on this scale? Fine, here’s non-partisan tax expert Bill Gale et al: “At the federal level, there is virtually no evidence that broad-based tax cuts have had a positive effect on growth…That has been amply demonstrated at the national level, where tax cuts have eroded revenue without discernable effect on economic activity.” Here’s national tax expert Joel Slemrod: “There is no evidence that links aggregate economic performance to capital gains tax rates.” Here’s the non-partisan Tax Policy Center: there’s “no statistically significant correlation between capital gains rates and real growth in gross domestic product (GDP) during the last 50 years.”
Big tax reforms from the left, like that of candidate Bernie Sanders, at least do better on the math, but assume a level of taxes and spending that go well beyond—by my reckoning, about 10 percentage points of GDP beyond—the U.S. historical model. To be fair, the man’s talking about a “political revolution,” so it’s no surprise that he’s outside the box.
Back inside the box, I learned an important lesson about Congress and tax reform when former Republican head tax-writer Dave Camp introduced a serious, comprehensive tax reform bill. The three-year effort was killed in about a New-York minute after it was introduced, and not by Democrats but by fellow Republicans. It didn’t cut rates enough for them. It introduced a tax on banks, causing their lobbyists to threaten the cancellation of GOP fundraisers.
In other words, what passes for a tax reform debate in this town is not serious.
But that doesn’t mean all is lost. To the contrary, Furman’s resonant message, at least as I read (and paraphrase) it, is: there’s a lot we’ve done and can do through the tax code that isn’t “fundamental reform” yet boosts both economic efficiency and the living standards of middle-class and low-income families.
There’s been no major tax reform since 1986, but Jason writes (my bold, and the acronyms refer to tax credits for low-income, working families):
The changes in the Federal tax code since 1986, including the substantial increases to the EITC and CTC…boosted the after-tax income of households in the first two quintiles of the income distribution by about seven percent without even counting any benefits from the additional labor force participation and earnings generated by the expansion of these tax credits. These gains are an order of magnitude larger than the estimated gains from fundamental tax reform, which are generally measured in the tenths of a percent.
So, let’s stop being distracted by the “fundamental reform fairy” and start pursuing incremental reforms:
— Close the carried interest loophole that privileges the earnings of investment fund managers. In a town where every tax break has a defender, that one stands alone. (Sen. Chuck Schumer used to support it on behalf of his constituents, but he’s backed off; even Trump’s against it!) Can we please put it out of its misery?
— Block corporate tax inversions, where U.S. companies merge with overseas companies just to move their tax mailbox to a low tax country.
— End the “step-up basis” provision by which the wealthy can pass capital gains on to their heirs tax free.
— Stop incentivizing multinationals to keep, or at least book, their profits overseas by letting companies repatriate their foreign earnings after paying a minimum tax (the Obama administration suggests a 19 percent minimum rate).
— Increase the EITC for childless adults, who now get very little from it, an idea supported by both Obama and House Speaker Paul Ryan (R).
Above, I called these “tweaks” as opposed to major reforms. Though the contrast is apt, it’s the wrong word, as any such changes are hugely heavy lifts. But heavy lifts are at least in the realm of the possible. And that’s the right realm to be in if we actually want to improve our tax code.