Can the income tax fund the government we want?

The income tax’s ever-narrowing base simply cannot support the nation’s spending demands, Gleckman writes.

Can the income tax fund the government we seem to want? Probably not.

Will lawmakers create a revenue system that will? Not anytime soon.

That was the consensus of four tax policy experts at an Urban Institute panel I moderated Tuesday afternoon. The panelists–historian Joe Thorndike, Urban Institute economist and tax reform veteran Gene Steuerle, Tax Policy Center co-director Eric Toder, and IRS taxpayer advocate Nina Olson– agreed that the current Swiss cheese of a revenue code is not up to the task, at least not in the long-term.  

And they agreed that someday, the federal government will turn to some form of a consumption tax to help make up the difference. It may be a broad-based levy such as a Value-Added Tax or an energy tax. It might replace the current income tax, or might be added on to the existing system. But given political gridlock, any form of major reform is years away.    

As they were speaking, the Congressional Budget Office released its own fiscal update for the next decade. And, by CBO’s estimates, the panelists are self-evidently correct. While a growing economy will bring the annual deficit down to about 2.4 percent of Gross Domestic Product by 2015 (assuming, among other things, that discretionary spending remains capped in the way Congress and President Obama have agreed), the red ink will begin flowing faster again. By 2023, the deficit will be back to 3.8 percent of GDP and rising. 

If, as is more likely, those spending caps erode and a raft of temporary tax cuts don’t expire as scheduled, the deficit will be closer to 5 percent of GDP in a decade. And, as 77 million aging Baby Boomers require more health and long-term care, deficits will head upwards in the decades after that.

There seems to be little political will, at the moment, to make major changes in Medicare or Social  Security. At the same time, the income tax remains riddled with preferences and other subsidies.

As a matter of math (as everyone used to say in the recent campaign), Congress could balance the budget in 2014 by eliminating about half the value of those tax expenditures. But since these are subsidies for such All-American activities as taking out home mortgages, getting employer-sponsored health insurance, paying state and local taxes, and making charitable contributions, Congress is unlikely to cut them in half anytime soon.

As long as these subsidies remain on the books, the income tax’s ever-narrowing base simply cannot support the nation’s spending demands. With the top tax rate now over 40 percent (including the phase-outs of the personal exemption and itemized deductions), Congress may be reaching the limit of its ability to continue to raise rates without facing the law of diminishing returns.

That leaves a consumption tax of some kind. But in the absence of a fiscal crisis (such as rapidly rising interest rates) lawmakers are not likely to travel that road any time soon, the panelists figured. So we will continue to muddle along, with an income tax that is ever-more complicated, harder to administer, and increasingly inefficient.

Tuesday afternoon’s panel celebrated (if that is the word) the 100^th  anniversary of the ratification of the 16^th Amendment, which created the modern income tax. The levy has been remarkably resilient over the past century, but without a huge change in the public’s appetite for federal spending (especially for health care) it is hard to see how the income tax as we know it can last another 100 years.