On December 11 the incoming chair of the Senate Finance Committee, Sen. Orrin G. Hatch, R-Utah, released a 339-page tax reform report written by his staff. It was too short.
It contained a lot of things we would expect from a Republican taxwriter: Tax reform should lower individual and corporate rates. There are significant opportunities for the simplification of pensions, child credits, the earned income tax credit, and education incentives. The alternative minimum tax should be repealed. The deduction for state and local taxes should be repealed. Business tax reform must provide benefits to small business as well as big corporations. On international tax, the United States should move to a territorial system, but anti-base-erosion measures will be needed and are likely to include a limitation on interest deductions and some sort of minimum tax on low-tax foreign-source income.
There were a few twists: At one point the report states, “The tax system in which the top one-tenth of one percent pays a lower average effective tax rate than the top one percent is not fair -- the tax system should be progressive even at the highest end of the income spectrum.” Since this low rate at the highest income levels is primarily due to capital gains rates (as the report itself points out), could this be an indication that repeal of preferential rates on capital gains might be tolerated?
For academics, there is a lot of discussion of the history of taxation in America and the elimination of double tax on corporate profits. There is also a meandering discussion of consumption taxes. (Consumption taxes include retail sales taxes, value added taxes, the flat tax, and a variety of cash flow taxes on business.) The reports blows hot and cold on these taxes. For example, on one hand, consumption taxes can promote growth because they do not share the income tax’s bias against saving and investment. On the other hand, politically necessary transition relief (for the elderly) and adjustments to reduce the disproportionate burden on the poor would eliminate most of the expected positive effects on growth. Also on one hand, other countries have used revenues from their value added taxes to reduce their corporate taxes (which is the most agreed-upon goal for U.S. reform). But on the other hand, the “adoption of a VAT would be a bad idea” because “it could cripple our economy” and “would be the most regressive tax ever imposed on the American people.”
But what is most interesting about the report is what is left out. There is a lot of discussion about lowering corporate and individual rates, but no mention of specific targets. (That’s a good thing because the oft-promised 25 percent rate is only fueling expectations that can't be met.) The report also offers no clues about what direction Hatch might take for limiting the deductions for mortgage interest, charitable contributions, or the exclusion for employer-provided healthcare. There is also no discussion -- either pro or con -- about prominent features of outgoing Ways and Means Committee Chair Dave Camp’s tax reform draft, including a tax on large financial institutions, requiring amortization of research expenditures, requiring amortization of advertising expenditures, and a special low individual tax rate for manufacturing and agriculture income of passthrough businesses.
On the critical issue of the scoring of tax bills (which will be central to the tax reform debate in early 2015) the report says a lot about the positive effects on labor supply from cuts in individual tax rates. But it is silent on other critical revenue estimating issues, including the negative growth effects from corporate tax reform (mostly due to the repeal of accelerated depreciation), whether or not the permanent extension of expiring provisions should be considered part of the baseline (which could trim nearly $1 trillion off the amount a reformed tax system would need to raise), and -- most importantly -- whether tax reform needs to be revenue neutral over the 10-year window traditionally used by Congress or whether it should be revenue neutral over the long run. This last issue is huge because so many of the major revenue raisers in tax reform are front-loaded.
There is one central question for the Finance Committee over the next two years: Will Hatch propose his own comprehensive tax reform package? As noted, Camp did it earlier this year. Sen. Ron Wyden, D-Ore., his Democratic predecessor as chairman, has done it. Republicans are complaining loudly that President Obama should do it. If -- as Hatch writes in the preface to the report -- “reform is vital and necessary to our nation’s economic well-being”-- should he not also go beyond publishing reports and principles and write a real bill?