Tax Reform Should Move to Congress’ Front Burner in 2008

Posted October 23, 2007 at 3:40pm

Back in the fall of 1985, I gave a talk to a group of tax policy specialists in which I outlined all the compelling reasons why serious tax reform was a non-starter — second-term presidents do not get sweeping initiatives enacted; large tax changes that are “revenue-neutral” mean there are sizable numbers of losers to go along with the winners, and the losers are outraged while the winners tend to be ungrateful; and so on.

[IMGCAP(1)]But I concluded with the reasons why despite the odds, tax reform still was likely to happen: There was growing and widespread anger about the tax system and its unfairness; both parties saw a need to act and a political incentive to do so (the then-Democratic House wanted to show voters it could be a do-something body, and President Ronald Reagan wanted a legacy); the common ground was surprisingly large, with the president embracing the principles of lower rates and a broader base embodied in the bill sponsored by Sen. Bill Bradley (D-N.J.) and Rep. Richard Gephardt (D-Mo.); and the president had forged a strong working relationship with Rep. Dan Rostenkowski (D-Ill.), the powerful leader of the Ways and Means Committee. Lo and behold, we did get robust reform the next year, breaking the political mold for lame-duck presidents.

Fast-forward 22 years. The tax system is once again an issue, with a widespread consensus that it is out of date, inefficient and skewed. But tax reform is not anywhere near the front burner. It is skirting around the edge of the policy process in Congress. Lots of Members are talking about taxes, including some of the key players, but it is clear that the time is not yet ripe for serious action. With the war in Iraq, children’s health insurance, electronic surveillance, appropriations wars and energy on the front burner, the tax system will have to wait.

To be sure, we will see tax changes, starting of course with the need to do something about the alternative minimum tax, soon to hit as many as 30 million middle-class families with unexpected and unpleasant tax bills, all an artifact of the 2001 tax cuts that were President Bush’s top domestic achievement. Other changes will flow in the next couple of years from that set of tax cuts, mainly because most of the key ones are set to expire in 2011.

It is bemusing to see Republicans charge that the failure of Democrats to act to extend those tax cuts, including capital gains and the full repeal of estate taxes, will amount to the largest tax increase in history — bemusing because they make it sound like they had nothing to do with the fact that the cuts will expire. But of course they made a deliberate and basically deceptive decision to make those tax cuts temporary to avoid the budget consequences, both in terms of procedures and budget projections showing ballooning deficits in the out years. The fact that these tax cuts expire automatically instead of requiring direct action to eliminate them is their fault and their fault alone.

No doubt, the Democrats in the majority in Congress will not let every tax cut expire. They certainly will not let the estate tax go down to zero in 2010 and then back to its previously sky-high levels in 2011, but they will look for a middle ground — the kind of reasonable common ground that could and should have been reached in 2001, with exemptions perhaps scaling up to $4 million, and rates lower than the previous 55 percent. But whatever tinkering they do in this area will not result in major change in the tax policy structure. And the hope that Ways and Means Chairman Charlie Rangel (D-N.Y.) expressed earlier this year, that he could use the need to erase that unexpected burden of the AMT by creating the Mother of All Tax Reforms, has clearly gone by the boards for 2007 and is on shaky ground for 2008.

If the conditions are not there just now for major tax reform, I hope it will be a serious issue in the 2008 campaign and that the next president makes it a major issue in 2009. The fact is, we have truly intriguing ideas and options out there and a chance in the next couple of years to create a much better tax system.

Sen. Ron Wyden (D-Ore.) has an interesting plan that builds on the 1986 income tax reform using the basic principles of lowering rates and broadening the tax base, while using tax credits instead of deductions in many places to level the playing field for people with working-class and middle-class incomes — in effect, with a redistributive twist. Michael Graetz, a law professor at Yale and former assistant Treasury secretary for tax policy, has a new book out with an intriguing and well-reasoned plan to replace all income taxes for those making up to $100,000 with a form of value-added tax.

Rep. John Dingell (D-Mich.) has thrown out the idea of a carbon tax as the most efficient way by far of reducing carbon emissions; a significant carbon tax would allow us to sharply reduce income and/or payroll taxes while reducing harmful emissions and improving the environment. And many of the health reform plans out there eliminate the tax break for employer-provided health insurance and substitute a substantial tax credit for everybody to pay for their health insurance; admittedly, on this one, the devil is in the details, but it adds to the prospects of a major overhaul of how we tax and for what purpose — and, I hope, a serious look at how much revenue we will need to raise to pay for the government that Americans continue to demand.

The good news is that on the left, on the right and in the center there is serious thought and there are open minds on how best to design a tax system that is fair, reasonable and workable, that creates appropriate incentives, and disincentives for behavior, that affects policy in a more direct way than through cumbersome bureaucracies. If Rangel and his counterpart on the Senate side, Finance Chairman Max Baucus (D-Mont.), cannot move the Mother of All Tax Reforms, or even the second cousin once removed, perhaps they can use their platforms for a more rousing discussion and analysis of all the ideas out there, stretching minds and opening doors that might be ready to enter in 2009.

Norman Ornstein is a resident scholar at the American Enterprise Institute.