Tax Analysts Blog

Is There Now a Window of Opportunity for Tax Reform?

Posted on Jan 26, 2015

Tax reform has been at the forefront of the debate about fiscal policy for over four years. In December 2010, at the behest of President Obama, Alan Simpson and Erskine Bowles issued their famous report (“The Moment of Truth”) that suggested getting rid of every tax break in the code and reducing the corporate and top individual rates to 23 percent. For all its contributions to the cause of deficit reduction, the tax component of their plan was something of a fraud -- it used tax reform as a smoke screen to make a tax increase more palatable to conservatives. Conservatives were not fooled. The Simpson-Bowles tax reform plan went nowhere.

Then in 2012, Mitt Romney ran for president and promised to reform the code and reduce corporate and individual rates by 20 percent. We learned something from the intense scrutiny that policies get during presidential campaigns: Most of the big individual tax breaks in the code (that are not incentives for saving) that tax reformers want to cut disproportionately favor the middle class. For Romney to get enough revenue to pay for his proposed rate reduction, he would have had to shift the tax burden onto middle-class voters. Romney's plan did not help his campaign.

And in February 2014, after three years of intense staff work and meeting with every special interest group in town, then-Ways and Means Committee Chair Dave Camp released a full-fledged, detailed tax reform plan. It repealed the alternative minimum tax and got the corporate rate down to 25 percent, but was only able to reduce the top individual rate from 39.6 percent to 35 percent. To pay for these rate cuts, Camp had to slash almost every tax break in the code. Camp personally got lots of praise for his courageous effort, but the plan got zero support—-even from his Republican colleagues.

Despite a battlefield littered with the carcasses of failed reform plans, there is now some hope for progress on tax reform. No, this is not the usual happy talk you find at the beginning of every new Congress. You know how every two years people say maybe this time things will be different because the election is over and members really are ready to put politics aside and get things done? No, there are specific developments that could increase the likelihood of tax reform. Namely:

(1) Republicans increasingly seem willing to accept the president’s preference that tax reform be limited to business and exclude individual rate cuts. Individual tax reform sounds good at first blush, but as Romney discovered in 2012, it is very difficult to pull off in practice.

(2) Since December the Obama administration has seemed ready to do more than talk about tax reform and start taking action.

(3) The House has adopted a rule that major tax legislation be dynamically scored. This means that if official estimators at the Joint Committee on Taxation believe a reform proposal increases economic growth, fewer politically painful cuts will be required.

(4) The new Republican chair of the Senate Finance Committee, Orrin Hatch, has announced that tax reform is priority for him. He has formed five bipartisan working groups that he expects to report back to him in late spring, and he has an excellent working relationship with the ranking Democrat on that committee, Ron Wyden (who is a devotee of tax reform and who coauthored his own tax reform plan with Republican committee member Dan Coates.)

(5) Most of all, the new chair of the Ways and Means Committee, Paul Ryan, has broken with Republican colleagues and greatly toned down the anti-Obama rhetoric.

What the president, Ryan, Hatch, and Wyden all realize is that it is in their interest to get tax reform done -- just as Ronald Reagan, Dan Rostenkowski, Bob Packwood, and Bob Dole did in 1986. This type of strong leadership is an essential component of any successful tax reform effort.

But—we are sorry to report--it probably will not be enough. Partisanship among the rank-and-file members of Congress is at fever pitch. Business support for tax reform may be strong in the abstract. But for actual tax reform plans like Camp's, support is lukewarm at best. Manufacturers don't like the plan’s slower depreciation and slimmed-down research credit. Multinationals don’t like the minimum tax on their foreign profits. Media firms don’t like the tougher tax treatment of advertising. Banks don’t like the new bank tax. And the list goes on.

But can’t dynamic scoring relieve the pressure on all these points? Unfortunately, not by much. Despite the large macroeconomic effects reported by some private groups, official estimates from the JCT are generally modest. They probably will not be enough to make the politics of tax reform much easier. Moreover, many of the positive macroeconomic effects in the JCT estimates of tax reform have come from cuts in individual tax rates. With those absent in a business-only reform, the dynamic effects will be much smaller. In fact, they may even be negative because the cuts in depreciation allowances included in most tax reform have significant negative effects on capital formation and economic growth.

So the window of opportunity that has opened in 2015 will be slammed shut once the presidential election heats up in early 2016. We will have to wait until 2017 for any real progress on tax reform. And by no means is there any guarantee of movement then.

In the meantime, the best we can probably hope for in the way of actual tax legislation is some sort of tax increase in late May to replenish the depleted Highway Trust Fund. Unfortunately, the gas tax is almost certainly off the table. That’s too bad, because it is an economically justified user fee. (Rural legislators complain that it unfairly burdens their constituents who have to drive 40 miles to work. But shouldn’t they have to pay for the roads they use?) The leading alternative to a gas tax increase is a low tax rate that would be imposed on the $2 trillion of foreign earnings of U.S. multinationals for the privilege of bringing those funds back to the United States free of regular income tax. (Note: Using this revenue raiser to replenish the Highway Trust Fund means this revenue source cannot be used to pay for low rates in tax reform.)

Besides this relatively minor accomplishment of actually dealing with the Highway Trust Fund, the only other notable outcome of 2015 tax policymaking is that members will be better educated about what the realistic possibilities for tax reform are. They will start to understand that their oft-stated goal of a 25 percent corporate rate is a pipe dream under a conventional tax reform plan (like that enacted in 1986). They may have to start thinking outside the box. Perhaps they will consider new revenue raisers, like limiting interest deductions or imposing a carbon tax. Or perhaps they will start moving away from conventional reform ideas and consider more fundamental types of reform like the X tax, which is just like a flat tax but with a more progressive rate structure. Another alternative would be to impose a VAT and use the new revenue to drastically reduce the number of individual taxpayers and reduce the corporate tax rate into the teens.

Read Comments (1)

edmund dantesJan 26, 2015

"Unfortunately, the gas tax is almost certainly off the table. That’s too bad,
because it is an economically justified user fee. "

That was once true, but it is no longer. Substantial portions of gas tax
revenue have been diverted away from paying for highways--enough to account for
the entire shortfall of the highway trust fund. If we simply made mass transit
projects pay their own way, there would be no need to increase the gas tax.

That explains the complete lack of support for such an increase.

I see zero evidence that the Obama administration has any serious interest at
all in meaningful tax reform. What is your evidence for point (2)? All I've
seen is consistent advocacy for higher taxes on anything that
breathes--businesses, middle class education savings accounts--and higher taxes
on the dead, by ramping up the federal estate tax.

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