All sides embrace tax reform that won't happen

Chances of substantial overhaul slim to none; lip service

Mar 17, 2013 @ 2:03 pm

Everyone in Washington celebrates tax reform. President Barack Obama embraced it in his State of the Union address. House Speaker John Boehner called it a top legislative priority. The House Ways and Means and Senate Finance committees are convening bipartisan working groups, and lobbyists are licking their chops.

To the president and Democrats, tax reform is an opportunity to create a more equitable tax code while bringing in more revenue to reduce the deficit; to Republicans, it's about cutting marginal rates, especially the top ones, to promote economic growth; to lobbyists, it's about padding their wallets.

It's a mirage, say a number of serious participants who would like to see something achieved. The chances of any substantial overhaul in this Congress are slim to none.

The U.S. tax code is riddled with special-interest provisions, economic inefficiencies and inequities. Yet every preference enjoys either popular support or influential backing from a vested interest.

This always makes the politics of tax reform daunting; in reshaping a code that hands out more than $1 trillion a year in preferences, there would be winners and losers. Inevitably, it's the potential losers who bring the most passion to the deliberations.

Revenue Neutral

What makes an overhaul next to impossible today is the added burden of total polarization: Democrats insist that any changes must result in net revenue gains; Republicans say any measure must be revenue neutral. Both sides agree that changing the way taxes are allocated is politically perilous and only can be done with bipartisan support.

That rules out any sweeping change, despite the genuine support of both the president and House Ways and Means Committee Chairman Dave Camp, a Michigan Republican.

It's conceivable, if unlikely, that a deal could be struck to replace the current across-the-board spending reductions under sequestration with some additional revenue along with cuts to entitlements. That could open the way for a modest tax overhaul that slightly lowers rates and cuts a few preferences.

The goal of strong reform advocates, to cut the top rate by as much as a third and slash loopholes, runs into current realities.

“Democrats just raised the top rate and Republicans say no more tax increases,” says Bill Gale, the director of economic studies at the Brookings Institution.

It might be a little easier to take up the tax system for businesses because there's a general consensus that changes should be revenue neutral. Camp wants to lower the top corporate rate to 25 percent from 35 percent; the administration wants to cut it to 28 percent.

Here, too, the trade-offs are tough. Even if the controversial foreign source issue is resolved -- the largest corporate preference is the ability of U.S.-based multinationals to defer taxes on income abroad -- with some acceptable global minimum tax, powerful sectors such as agriculture, mining and real estate could face higher taxes.

The same could apply to partnerships, a sector that includes law firms and financial companies with clout. (Camp floated a surprising proposal last week that would curtail the ability of partnerships, such as hedge funds and private equity firms, to allocate income and tax benefits among their members.)

Untouchable Exclusions

On the individual side, the demand for more revenue means the losers outweigh the winners. Yet experience shows that most of the biggest preferences -- charitable write-offs, the deductions for home mortgages and state, local and property taxes and the exclusion of health-insurance benefits -- are close to untouchable.

Republicans offer several ways to circumvent these obstacles. One is to put a ceiling on overall write-offs instead of attacking individual subsidies. The problem with that idea, as former Massachusetts Governor Mitt Romney discovered when he made a vague campaign pledge along these lines, is that it would hit hard taxpayers who make $100,000 to $200,000 a year, and who don't consider themselves rich, and vote heavily. The other impediment is the Republican argument that there's no need for net new taxes because effective reform would promote economic growth and bring in more revenue. The evidence for that is flimsy.

All right, proponents still say, some periodic overhaul of the code is essential and Washington overcame similar obstacles with the sweeping 1986 Tax Reform Act. It's true that rates were lowered and the base was broadened. However, it was financed with huge increases in corporate and capital gains taxes, both of which would be off the table today for Republicans and more than a few Democrats.

In 1985-86, there also was real bipartisan cooperation among a Republican president, Ronald Reagan, Treasury Secretary Jim Baker and Democratic lawmakers such as Representative Dan Rostenkowski and Senator Bill Bradley. Even then it took almost two years and on several occasions the effort very nearly died. No trace of that spirit exists today.

Still, a major discussion of tax reform this year would be healthy. It could be educational, underscoring the deficiencies and unfairness of the code and the tough trade-offs required to make it better. That could lead to gradual changes and improvements at the margins.

It also probably would be a boon for the Washington economy, as special interests rush to hire any lobbyist with a pulse to protect their benefits.

--Bloomberg News--

(Albert R. Hunt is a Bloomberg View columnist. The opinions expressed are his own.)


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