Tax reform is possible, but not easy

Substantial tax reform may still be possible, but not easy. The biggest hurtle isn't in forming a comprehensive plan, which has been done before, but in selling it to members of congress. 

At a Tax Policy Center conference on tax reform yesterday, Jason Furman, the chair of the President’s Council of Economic Advisors, said that a major rewrite of the tax code would make little progress until Congress breaks the current impasse over the treatment of pass-throughs-- firms such as partnerships and S corporations whose owners pay tax on their individual tax returns.

Furman said there was more potential for action on the corporate side, where policymakers have broadly agreed to reduce U.S. corporate tax rates. But even that effort faces a big hurdle: The biggest beneficiaries of corporate rate cuts would be big multinational firms but most proposals to pay for those rate reductions would eliminate tax preferences that benefit both corporations and pass-throughs. Those pass-throughs, which make up the vast majority of US businesses, would aggressively oppose such a trade-off.

Yesterday’s conference commemorated the 10^th  anniversary of President George W. Bush’s Advisory Panel on Federal Tax Reform.  That bipartisan group, led by former senators John Breaux (D-LA) and Connie Mack (R-FL), also included economists and business executives. And it developed two plans for broad-based reform, a simplified income tax and a business cash-flow tax. Both were credible, well-designed ideas, but the commission report got no support from the Bush Administration or Congress and went nowhere.

Still, many of its ideas have surfaced in more recent tax proposals, including several made this year by the major GOP presidential candidates. The one big difference: The Tax Panel’s plan raised the same amount of money as the then-tax code (under the assumption that the 2001-03 tax cuts would be made permanent). Today’s versions are all enormous tax cuts.

A panel of commission veterans agreed that it may be possible, though hardly easy, to enact broad-based reform. However, they candidly acknowledged the hurdles, some of which may be higher today than in 2005.

MIT economist Jim Poterba said that two big economic changes in the past decade complicate reform because they create what may be conflicting goals.

On one hand, persistent slow growth in the US economy increases demand for pro-growth reform, which would include lower taxes on capital income (though Poterba acknowledged that evidence for exactly what changes would best accomplish those goals is weak). On the other hand, growing concerns about income inequality make it more difficult to reduce taxes on capital, which could boost after-tax inequality.

Following the public program, TPC’s Leadership Council met to discuss many of these issues. The council is made up of business leaders and other outside experts who advise TPC and make unrestricted financial contributions to the center.

As Jason noted, there is widespread support for corporate rate cuts. What there is not, however, is any consensus on how to finance those cuts without adding the budget deficit . At the leadership council meeting,  my colleague Eric Toder outlined four possible options: 1) eliminating business tax expenditures (2) enacting other measures to raise taxes from businesses such as limiting the deductibility of interest or requiring large pass-throughs to pay corporate income tax,  3)raising tax rates on capital gains and dividends or 4) enacting a new revenue source, such as a carbon tax or a value-added tax.

While each of those approaches may have policy merit, none has anything close to enough political support to make business reform happen.

Is all lost? Not necessarily, former Senator Breaux, a long-time member of the Senate Finance Committee, told the morning conference. Developing a credible plan is not the biggest challenge, he said. The Bush commission and others have already done that. The challenge is to wrap the idea of reform around a simple, compelling story that lawmakers can understand. As Breaux put it, “You’ve got to be able to sell it to members of Congress who don’t know the difference between a balance sheet and a tax return.”

That seems easy enough.

This article first appeared at TaxVox.