The Conventional Wisdom of Tax Reform

In the Times this weekend, David Leonhardt has a generally good overview of the tax policy showdown that is scheduled for later this year, as the Bush tax cuts approach expiration on January 1. He outlines several of the central issues we face: “hypothetical solutions are a lot more popular than actual ones”; everyone says she wants tax reform, but the tax expenditures that would have to be eliminated are very popular; and any significant deficit solution will directly affect vast numbers of Americans.

I have a few differences with Leonhardt, however. First, after his colleagues David Brooks and James Stewart, he seems to have fallen briefly under the spell of Paul Ryan: “Mr. Ryan’s plan would cut the top rate to 25 percent, from 35 percent, and still leave overall tax collection roughly where it has been, by eliminating tax breaks.”

Paul Ryan has no tax reform plan. His bizarrely much-heralded “plan” is to cut tax rates to specific levels (25%, at the top end) and “broaden the tax base to keep revenue as a share of the economy at levels sufficient to fund critical missions that rightly belong in the domain of the federal government.” Nowhere does he say how he would broaden the tax base. This is a statement of an objective, not a plan.

As Leonhardt says, “What’s missing from these plans is any detail on which tax breaks would be eliminated”—which means they should be taken as political gambits, not as tax reform plans. A plan, like Domenici-Rivlin or chapter 7 of White House Burning, has to say what you would actually do, and Ryan fails that simple test.

More importantly, Leonhardt propagates a misleading framing of tax reform:

“The notion of tax reform also has widespread support from economists, liberal and conservative. As they define it, reform would reduce marginal tax rates while eliminating or reducing various tax breaks.”

There’s no definitional reason why tax reform has to reduce marginal rates. You could simplify the tax code and eliminate loopholes, reducing both administrative and compliance costs and economic distortions, without touching marginal rates. Sure, this would increase revenues. But it seems pretty obvious to me, as it would to a third grader, that if the problem is the budget deficit, then you want to increase revenues.

It’s also obvious to Daniel Shaviro, a leading tax professor who has been writing about deficits and tax reform for well over a decade.  From the abstract:

“First, if tax expenditures are properly viewed as spending through the tax code, a revenue neutrality norm in which the budgetary gain from their repeal ostensibly needs to be offset by rate cuts is intellectually incoherent. Second, the long-term U.S. fiscal gap makes rate-cutting, in particular for individuals, potentially imprudent. Third, if one wants to address rising high-end income concentration in the United States since 1986, the option of raising, rather than reducing, the top marginal income tax rates may need to be squarely considered.”

You may disagree with the third point, but the first two seem pretty irrefutable to me.

So why do people inside the Beltway reflexively equate tax reform with lower rates? It’s a political question, not a substantive policy one. Everyone knows that you can’t get any Republican votes for any bill that increases tax revenues. Ergo, there are only two ways tax reform could pass: either you make it revenue neutral—in which case you should admit that it will have no impact on the deficit—or you wait for (and campaign for) a Democratic sweep. Since doing the latter is “partisan” by definition, most wannabe centrists settle for the former. But it is certainly not correct to say that “liberal” economists define tax reform as rate reduction.

The other problem with revenue-neutral tax reform is that it presumes that the overall tax level set by the Bush tax cuts—lowered from the 1997 budget bill, itself lowered from the 1993 budget bill—is the right one. Revenue-neutral tax reform would make permanent a set of huge tax cuts that were passed (a) when the budget was almost in balance, (b) before the huge expense of the Iraq War, and (c) before the financial crisis and ensuing recession. Those tax cuts are due to expire precisely because the Bush administration could not find sixty votes in the Senate for them, and had to use reconciliation. If we’re going to aim for revenue neutrality—even though, as Shaviro points out, the concept doesn’t make sense because of the tax expenditure phenomenon—there’s no compelling reason why current tax rates should be the baseline rather than current tax law, in which we revert to 1997 rates on January 1.

The problem is that the conventional wisdom inside the Beltway is that tax reform means rate reductions to achieve revenue neutrality at Bush levels. If people believe that, Grover Norquist has already won.

This post originally appeared at The Baseline Scenario and is posted with permission.

2 Responses to "The Conventional Wisdom of Tax Reform"

  1. Ed Dolan
    EdDolan   April 16, 2012 at 12:35 pm

    Why not revenue enhancement AND lower marginal rates via reduction of tax expenditures? Why pose the question as rate reductions with revenue neutrality vs. revenue enhancement leaving marginal rates where they are? There should be a middle ground.