It is presidential primary season and once again the tax code is a punching bag for politicians on both sides of the aisle. Listen to their rhetoric and it’s easy to conclude that the tax policy differences in today’s hyperpartisan political environment are so great that reform is doomed.
But it doesn’t have to be that way. Ten years ago this week, a nine-member bipartisan tax reform panel established by President George W. Bush unanimously agreed to two bold options for reform – a radically streamlined version of our existing system and a growth-oriented plan designed to encourage investment. At the Brookings Institution on Tuesday, some of the veterans of that panel will discuss lessons from our experiences. To learn more, click here.
The panel, led by former Senators Connie Mack (R-FL) and John Breaux (D-LA), wrote a detailed report that diagnosed the problems with our income tax system and offered bold ideas that would result in a simpler, fairer and more growth-oriented tax code. Although the panel’s reform options were never enacted, they created a playbook for leaders willing to move beyond the political expediency of tweaking tax rates or adding new tax benefits. The panel focused on the most pressing problems in our tax code.
A Tax Code that Multitasks – Our tax code has become government’s preferred tool for providing subsidies designed to encourage various desirable activities. Remarkably, we give away almost as much in special tax breaks as we collect from the entire individual income tax. This is a poor way to collect taxes and a wasteful approach to running government.
Congress doesn’t evaluate whether these subsidies are delivered efficiently and in many cases they duplicate existing spending programs. In addition, the IRS must regulate all sorts of activity unrelated to raising revenue, such as which health insurance you buy or what car you drive. The tax system is so bloated that Americans have forgotten its purpose is to raise revenue to fund the government.
The panel proposed curbing the clutter in our tax code by recommending that special preferences only be granted when it could be persuasively demonstrated that they justify the cost – the higher taxes that must be collected from all taxpayers.
A Pie with Big Slices – A handful of tax benefits for home ownership, saving, charitable giving, and access to healthcare represent an enormous share of forgone individual tax revenues. The panel found that leaving these sacred cows untouched left little room for rate relief, a key benefit of reform. At the same time, eliminating most other tax benefits antagonizes vocal interest groups without generating much revenue.
As a result, the panel retained some tax benefits that promote widely shared and valued goals but made these incentives simpler, fairer, and more efficient. For example, it proposed streamlining and simplifying the earned income tax credit and various savings accounts.
An Internal Tug-of-War – The tax code is locked in an internal struggle between granting benefits and limiting their cost. As a result, policymakers have created a multitude of floors, phase-outs, and ceilings that benefit narrowly-targeted taxpayers. For example, the deduction for state and local taxes is subject to a floor from the standard deduction, a limitation from the itemized deduction phase-out, and a ceiling from the Alternative Minimum Tax (AMT). This complexity leads to the perception that many people don’t pay their fair share and that our tax system rewards those who can find loopholes to reduce their taxes.
The panel proposed eliminating this complex gimmickry and making benefits widely and transparently available to most taxpayers. For instance, it proposed extending tax favored treatment for health insurance, as well as tax benefits for charitable giving and home ownership, to all taxpayers. The panel also lowered tax rates and eliminated the AMT.
A Business Tax Code from the Mad Men Era – Our antiquated business tax system has failed to keep up with an economy that has changed dramatically as a result of globalism, technology, and new capital flows. The corporate tax base has been eroded by the expanded use of nontaxed entities, such as S corporations and partnerships, and aggressive international tax planning. The tax code also favors debt over equity and hinders economic growth.
The panel proposed bringing the tax code into the 21st Century by eliminating outdated and formalistic rules and taxing similar types of income more uniformly, regardless of the type of business that earned it or the reach of its global operations. It also proposed aligning financial results and taxes, a step that would help eliminate the need for many firms to keep two sets of books. Small business would use more cash accounting and big businesses would make greater use of their financial statements to calculate their taxes.
The problems identified in 2005 have only gotten worse over the past decade. But when we cut through all the heated rhetoric, the range of solutions remains clear. There is no need to reinvent the wheel. The Bush Tax Panel proved that Republicans and Democrats can work across the aisle – and the Panel’s report still serves as a solid foundation for a simpler, fairer, and more growth-oriented tax system.
Jonathan Ackerman, Rosanne Altshuler and Jeffrey Kupfer were, respectively, the senior counsel, senior economist, and executive director of President George W. Bush’s Advisory Panel on Federal Tax Reform.
This article first appeared at TaxVox.