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Does the Debate Over Tax Reform Really Matter?

4 min readBy: J. D. Foster, Ph.D.

TaxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. policy people have been beating the drum for tax reform since before the ink was dry on the 1986 Tax Reform Act. Fundamental tax reform obviously enjoys some level of sustained support, but the support has never been enough to propel tax reform over the top. Even with Steve Forbes trying his hardest to advance his Flat TaxAn income tax is referred to as a “flat tax” when all taxable income is subject to the same tax rate, regardless of income level or assets. , tax reform today seems to be not quite dead, but still a far cry from center stage.

After so many years of frustrated debate, does tax reform still matter?

Most certainly. The motivations for tax reform are as valid today as ever, if not more so. The federal income tax is (fill in your favorite expletive). And that is just one part of an overall federal tax system that is even worse, which in turn is part of a federal, state, and local tax system combining thousands of levies great and small, each with its own set of rules, regulations, and exceptions. The waste associated with administering and complying with this system certainly reaches into the hundreds of billions of dollars.

Furthermore, even though our economy continues to grow, the evidence is convincing that we could permanently increase the long-run rate of growth, and possibly the near-term growth rate as well, by replacing the federal income tax with a consumption taxA consumption tax is typically levied on the purchase of goods or services and is paid directly or indirectly by the consumer in the form of retail sales taxes, excise taxes, tariffs, value-added taxes (VAT), or an income tax where all savings is tax-deductible. of some kind. Failing to take policy actions to capture this additional growth is simply leaving money on the table. America is prosperous, but not so prosperous that it can afford to be foolish.

Because a stronger economy is tax reform’s strongest argument, the economy’s sustained sound performance has sapped tax reform of much of its vitality. The economy’s success has produced rising wages and profits while easing the fears and strains of the inevitable dislocations of an evolving market. Voters have simply become more interested in preserving the status quo than they are in undertaking the difficult process of reform in the hope that times could be better.

Stronger economic growth is not the only motivation for fundamental tax reform. A great many other cases have been made. And yet fundamental tax reform seems as distant a hope today as it did five or even ten years ago. Only the evangelistic few shake their heads at such defeatist talk, murmuring like cloistered monks to themselves and to anyone who will listen that the nation will see the light any moment now. Tax reformers are, if anything, a persistent lot.

If tax reform is truly such a far off proposition, why does it matter?

Because there will always be tax bills. Every year the pressure builds anew to pass a tax bill. For one thing, there are the “extenders,” tax provisions like the Research and Experimentation Tax CreditA tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly. that are well supported, but not so well supported that they can be made permanent.

Then there is the need for tax policy maintenance. The tax code is always evolving through letter rulings, new regulations, new court rulings, and the like. Sometimes these below-the-surface developments require congressional legislative attention. Meanwhile, tax advisors are continually developing new “products,” a fancy term for gimmicks to reduce a taxpayer’s tax bite by slipping a few dollars through a crack in the tax code. Sometimes, these tax devices are beyond the pale deemed acceptable by the Administration or the Congress and must be fixed legislatively.

More important than the extenders and maintenance, however, are the tax increases and decreases proposed by the Administration and Members of Congress. This is where tax policy evolves. This is where tax reform becomes critical. Even if fundamental reform, meaning the adoption of some manner of consumption tax, remains as distant as obeying the Ten Commandments forever and always, tax reform still provides an ideal toward which policy can evolve and against which proposals can be measured. Without such an ideal the tax code would travel ever in circles, driven by the latest political, social, or policy fad.

Absent enactment, the role of tax reform is to guide tax policy’s baby steps. Seen in this light, the influence of the tax reform debate was clear in the adoption of the Roth Individual Retirement Account (IRA), the Education IRA, and the Medical Savings Accounts. Capital gains taxes are down, and further reductions are possible. The Congress voted to phase out the estate taxAn estate tax is imposed on the net value of an individual’s taxable estate, after any exclusions or credits, at the time of death. The tax is paid by the estate itself before assets are distributed to heirs. in the recently vetoed tax bill. To be sure, many tax provisions in both the 1997 and 1999 tax bills had little to do with tax reform, like the per child tax credit, while others took small steps in the wrong direction. Nevertheless, intentionally or not, the tax reform debate’s influence on tax legislation is significant and is the cause for hope.

Tax reform matters a great deal.