Tax reform: Why a kinder, simpler tax code eludes Congress, so far

As Tax Day nears, Americans in the throes of preparing their returns may be dreaming of a simpler tax code. Here's why tax reform is such a tall order for Congress – and how two lawmakers are laying the groundwork for it now.

Focus

A popular president and a divided Congress endure first a divisive fight over immigration reform and then a swarm of lobbyists to pass an overhaul of the US tax code. Sound like a fantasy for President Obama's second term?

It's actually the story of 1986, when President Ronald Reagan, House Ways and Means Committee Chairman Dan Rostenkowski (D) of Illinois, and a GOP-led Senate succeeded in revamping the national tax structure for individuals and corporations.

A generation ago, Reagan's bipartisan accord pushed down tax rates by stripping out tax breaks tailored for narrow groups – helped along by a bump up in overall taxes paid by corporations.

Today, Mr. Obama and congressional leaders of both parties are talking as if it's 1986 (except for the part about sticking corporations with the tab). The conversation generally revolves around stripping out tax loopholes and reshaping what remains in a bid to reduce overall tax rates and simplify the entire system.

But as Americans rush to file their tax returns to Uncle Sam by the April 15 deadline, odds are they're likely to be stuck with the current unwieldy system for at least a few more years.

Don't tell that to the current House Ways and Means Chairman Dave Camp (R) of Michigan and Senate Finance Chairman Max Baucus (D) of Montana. They are determined to ensure that Congress will be ready to act should tax reform's moment arise – perhaps as part of a fiscal "grand bargain" later this year.

To tax reform advocates, the federal tax code is a shambling behemoth, its immense girth weighing down corporations and Jane and Joe Taxpayer alike. The code is more than 4 million words long and has been tweaked 4,680 times since 2001, or more than once a day, according to the Internal Revenue Service's National Taxpayer Advocate, whose job is to champion the poor schlubs who have to contend with the US tax system. Compliance takes more than 6 billion person-hours a year and costs $168 billion, the advocate's office reports.

Tax expenditures – the sober name for myriad loopholes, carve-outs, and incentives in the code – shield almost as much in revenue, at just over $1 trillion, as the $1.4 trillion collected each year.

Corporations, in particular, have a big reason to want to give up tax breaks in return for lower overall tax rates: The top corporate tax rate of 35 percent is the highest in the developed world (though many corporations pay less, thanks to tax shields).

Many Americans would no doubt welcome a simpler tax system, but taxpayers aren't exactly leading a rebellion over the issue. Only 2 percent of Americans listed taxes as among the most important problems facing the country, according to a December Gallup/USA Today poll. And just one-third cited tax complexity as the biggest issue in the code.

Complexity does have costs – tax experts say it exacerbates the "tax gap," or the spread between what government should collect and actual tax receipts, as businesses in particular struggle to meet sometimes-confusing obligations. Tax reformers argue that a code the public can't understand is a code Americans don't trust, undermining confidence in the government.

On balance, though, complexity's negatives are "overstated," says Douglas Holtz-Eakin, a former director of the Congressional Budget Office. "Most complexity comes from things people want."

The goodies

In other words, complexity stems from all the special goodies embedded in the tax code. Objections from the special-interest groups that protect them are one reason that rooting such benefits out of the tax code is so difficult.

"Talking about tax reform is always good to get lobbyists to write checks [to politicians' campaigns]," says Bruce Bartlett, a former Reagan economics adviser-turned-critic of GOP economic orthodoxy. "Doing tax reform isn't."

It may come as a bit of a surprise that, ever since President George W. Bush's tax cuts in 2003, 6 in 10 Americans say their individual tax burden is fair, according to Gallup. Thus, not so many are eager to make taxes simpler by, say, axing popular deductions such as the one for mortgage interest (worth $70 billion a year) or the one for pretax treatment of employer-sponsored health insurance ($131 billion).

Congress would have to raid some of those big deductions, however, to offset any large drop in top income-tax rates. Representative Camp, for example, envisions collapsing today's seven tax brackets down to two – 25 percent and 15 percent.

Whether either of the two political parties will eventually swallow hard and go along with Camp's broad outlines is anyone's guess. "We haven't had that conversation in Congress yet, saying, 'How low will we go and what [deductions] will disappear?' " says Annette Nellen, a tax professor at San Jose State University in San Jose, Calif.

(In a joint op-ed in The Wall Street Journal Sunday, Baucus and Camp said their final reform push would manage to lower rates without increasing taxes on poor and middle-income families.) 

This lack of clarity is in part because Camp and Senator Baucus aim to channel tax reform through the tried-and-true "regular order" of legislating – meaning committee hearings, lots of public input, and a record of all the tax reform arguments.

But specificity is also hard because there's pretty much only one thing Americans agree they'd give up: rich people's money. Indeed, their sense that the wealthy don't pay enough has been on the rise. Fifty-seven percent cited that as their top tax concern as of late 2011, up from 51 percent in 2003, according to a March 2012 analysis from the Pew Research Center for the People & the Press.

Higher taxes for the wealthy is where Camp and Baucus, for all their bipartisan comity, break. Camp, and Republicans in general, see tax reform as a "revenue neutral" way to simplify the code, meaning it would not add a nickel to federal coffers. But to bring rates down, they would need more people to pay into the pot, including some of the "47 percent" of Americans whose incomes are low enough to exempt them from paying federal income taxes, as GOP presidential nominee Mitt Romney famously noted.

"It's very difficult to lower rates in a revenue-neutral matter without raising taxes on people with relatively modest incomes," given the current tax code, Mr. Bartlett says. "It's not politically doable."

Baucus is in a tough spot, too. His Democratic caucus and Obama see tax reform as a way to deliver new revenues to help reduce the long-term budget deficit. But the six-term senator from Montana is up for reelection in 2014, and a bold stand on higher taxes in a tax-reform plan that may never pass could well prove damaging in conservative Montana. His hesitancy on the issue was evident during the recent budget debate, when he voted against five nonbinding tax measures – including his own party's budget, which called for nearly $1 trillion in new tax revenues over 10 years.

Even so, progress

Despite their political differences and the long odds, Camp and Baucus have made strides on tax reform. The two meet weekly, building a bipartisan tether across Capitol Hill.

If the president and Congress should decide to undertake tax reform as part of a sweeping grand bargain on America's fiscal condition – something lawmakers expect to see attempted yet again this summer – the pair are in a position to lead the debate.

Both have worked to educate the rank and file on taxes – Baucus through weekly meetings with Senate Finance Committee members, and Camp through a flurry of meetings with House lawmakers and the establishment of about a dozen tax study groups. Together, they are building institutional knowledge and policy muscle akin to what developed in the decade before the 1986 reform.

While neither has produced a comprehensive tax reform draft, their deliberate process has borne some fruit: Camp has offered three bites at the tax reform apple, including tax revamps for small businesses and financial products, while Baucus has homed in on tax complexity.

Hearings and letters from interest groups have helped to set the parameters of the debate, calling attention to America's relatively high corporate tax rate and sketching changes that might be politically possible.

"We are not writing a tax-reform bill in some ivory tower," Camp said at a recent hearing.

If tax reform is to move this year, it will almost certainly begin in the House. Speaker John Boehner (R) of Ohio has backed Camp's full-steam-ahead approach, offering Camp's eventual bill the designation of HR-1 (House Resolution 1), to signify that it's a top priority.

It's unclear whether Obama will put his political might behind tax reform, as Reagan did.

"This president's only utterances on tax policy have been about how the rich don't pay enough," says Mr. Holtz-Eakin. "The wild card remains the administration. There will come a point where [Obama] will have to materialize, and materialize forcefully, to get this over the finish line."