Political Hay

The Tax Reform Trap

So long as government keeps growing, don't expect a tax-reform commission to work miracles.

By 10.25.05

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Former Sens. Connie Mack and John Breaux can't win. The presidential tax-reform commission they head hasn't even released its final report yet and many conservatives are already as unhappy with its handiwork as they are with Harriet Miers.

By now, everyone knows that the existing tax code is hopelessly complex, riddled with loopholes, and biased against productive economic activities like saving and investment. The Mack-Breaux panel's task was to devise a simpler, fairer, less costly system that would promote economic growth without costing the Treasury money, all in a form that could conceivably become law.

The commissioners discovered this was a tall order. Consider one problem they had to address. The alternative minimum tax (AMT) was intended to keep rich people from taking advantage of so many tax breaks that they paid little or no taxes. But it isn't indexed to inflation and is increasingly gobbling up middle-class families' incomes. Left alone, the AMT may affect nearly 30 million taxpayers by 2010.

So the Mack-Breaux panelists appear to be leaning toward AMT repeal, a move that would simplify the code and offer tax relief. But it wouldn't be revenue-neutral: commissioners believe repeal would cost $1.2 trillion in ten years. In order to compensate, they are reportedly considering limiting the mortgage-interest deduction to $300,000 or $350,000 of a mortgage instead of the $1 million limit under current law. Since even getting rid of the mortgage-interest deduction entirely wouldn't raise $1.2 trillion, tax-free employer-subsidized health care and deductions for state and local taxes may also be on the table.

Such a plan would not rally conservatives. Lawrence Hunter, chief economist for the Free Enterprise Fund, complained to the Washington Times that the "tax-reform panel is recommending a huge tax cut for rich people in blue states and a huge tax increase for middle-class folks in the red states." Other bolder plans have gained a wider popular following than anything the president's commission is likely to propose -- or that Congress is likely to enact.

Tax simplification was supposed to be a winning issue. What gives? The Mack-Breaux commission has fallen into the perennial tax-reform trap: real and lasting reductions in the federal tax burden are impossible until the federal government sheds its substantial and growing spending commitments. As long as Washington spends the vast sums the IRS sucks out of the private economy, reformers can either make the code simpler while hitting some Americans with higher taxes or incentivize investment with consumption-tax schemes that mirror the complexity of the income tax.

Since their emergence as the tax-cutting party in the 1980s, Republicans have repeatedly tried to wriggle free from this trap. Supply-siders led by Jack Kemp argued that the "root-canal politics" of budget cuts were unnecessary because lower marginal rates would enlarge the tax base sufficiently to fund the voters' favorite government programs.

When marginal tax rates stretched all the way to 70 percent, this position had some merit. The Reagan tax cuts touched off extraordinary economic growth, which swelled federal revenues. Deficits ballooned to 6.3 percent of GDP but subsided to 2.9 percent by 1989, even though the top rate had been slashed to 28 percent. There were budget cuts, but overall federal expenditures rose even faster than revenues and most major programs remained intact.

But it didn't last. Rising payroll taxes, driven by retirement spending commitments, ate into middle-class tax relief. As deficits persisted, the top statutory marginal tax rate crept upward, reaching 31 percent as a result of the 1990 budget deal and 39.6 percent in 1993. Tax rates never returned to their pre-Reagan levels, to the lasting benefit of the economy, but they would likely be lower today if Republicans had paid as much attention to spending as to taxes.

Instead of emphasizing supply-side tax cuts that may eventually increase receipts, conservatives are now more likely to call for "starving the beast." Under this theory, tax cuts can force Congress to shrink government by reducing the available revenue. The starve-the-beast argument has always had shortcomings. Deliberately running deficits doesn't seem fiscally responsible; touting the revenue-losing effects of tax cuts reinforces liberal claims based on dubious static projections.

The biggest problem with the argument, however, is that it appears to be wrong. Taxes were cut in 2001 and 2003, but instead of forcing budget cuts Congress and the Bush administration engaged in a massive spending spree. Despite the deficit hawks' best effort, the beast's appetite is unabated.

Republicans are always looking for ways to limit the taxes voters despise while protecting the programs they rather like. The periodic assaults on the internal revenue code have become just another attempt to square this circle. Yet no tax-reform commission can change the basic fact that big government requires big revenues.

To be sure, the worst excesses of the tax system can be alleviated. The rate structure could be flatter and the number of deductions reduced. We could delete provisions that distort markets or inhibit growth. But as long as the federal government continues to grow, more ambitious reformers will find themselves caught in the same old trap.

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About the Author

W. James Antle III, author of the new book Devouring Freedom: Can Big Government Ever Be Stopped?, is editor of the Daily Caller News Foundation and a senior editor of The American Spectator. You can follow him on Twitter @jimantle.