Over the next few weeks, Republican lawmakers plan to introduce legislation to overhaul the U.S. federal 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. code. But before the public has even seen the text of a bill, a debate has emerged about the terminology that should be used to describe the endeavor.
Republicans typically use the phrase “tax reform” to describe their efforts to overhaul the tax code. However, several left-of-center writers have argued against that label, claiming that Republican lawmakers are more interested in “tax cuts” than in “tax reform.”
Because Republican lawmakers have not yet finalized a tax proposal, it’s hard to say right now which label will be more appropriate to describe their forthcoming legislation. But while we’re waiting, it may be worth trying to lay out some markers, to determine which bills should or should not be characterized as “tax reform.”
Level vs. Structure
When analyzing a given tax system, there are generally two key questions. First, how much revenue does the tax system raise? Second, how does the tax system go about raising that revenue?
The distinction between the level of tax revenue and the structure of a tax code is key to understanding the definition of “tax reform.”
Much of the debate about tax policy in the United States focuses on the level of federal revenue. These debates tend to be intensely ideological: conservatives generally contend that the U.S. tax burden is too high, while liberals often argue for increasing tax collections to fund additional government services.
But arguably, the more important questions in U.S. tax policy have to do with the structure of the tax code. These questions include: which deductions and credits taxpayers are able to claim, which economic activities are double-taxed or exempt from tax, which taxes the government relies on more heavily to raise revenue, what rules are put in place to prevent tax avoidance, and how complex the overall tax system is.
In the course of day-to-day politics, questions about tax level and tax structure are often closely intertwined. For instance, if lawmakers propose ending a deduction for manufacturing companies, they are calling for a change to the structure of the tax code (the elimination of a tax preference) as well as a change to the level of federal revenue (higher overall tax collections).
However, there’s no fundamental reason why discussions about the structure of the tax code need to be so closely tied up with debates about the level of revenue. In practice, many tax bills are primarily focused on one aspect of the tax system or the other. For instance, some bills, such as the Bush tax cuts of 2001, are designed to raise or lower federal revenue, with little modification to the underlying structure of the tax system.
But other pieces of legislation are primarily focused on improving the structure of the federal tax code, rather than changing the level of taxation. Bills that fall into this latter category are often referred to as “tax reform.”
Deciding Whether a Bill Counts as Tax Reform
In the real world, it’s not always easy to determine whether a piece of legislation should count as “tax reform.” Consider the following two examples:
Example A
Imagine that Congress has assembled a detailed legislative package aimed at improving and simplifying nearly every structural aspect of the U.S. tax code. The bill would eliminate over 50 targeted tax preferences, including nearly every business credit and almost all itemized deductions. Furthermore, the bill would reduce several perverse incentives in the federal tax code, such as the bias against new business investment, the bias toward debt financing, the double taxation of corporations, and the penalty for multinationals that bring back offshore earnings. However, the bill would also reduce federal revenue by about $1 trillion over 10 years, even after accounting for the bill’s positive macroeconomic effects.
Example B
Imagine that Congress has assembled an extensive legislative package aimed at lowering taxes across the board. The bill would slash the corporate tax rate to 15 percent, with little effort to make up for the lost revenue by eliminating corporate tax preferences. In addition, the bill would substantially reduce individual income taxes, by doubling the standard deductionThe standard deduction reduces a taxpayer’s taxable income by a set amount determined by the government. It was nearly doubled for all classes of filers by the 2017 Tax Cuts and Jobs Act (TCJA) as an incentive for taxpayers not to itemize deductions when filing their federal income taxes. and preserving the personal exemption, which would take millions of middle-class households off the individual tax rolls. Between these changes and several others, the bill would lower federal revenue by $4 trillion.
These two examples show the difficulty figuring out when “tax reform” is an appropriate label to apply to a piece of legislation.
The bill in Example A seems to have all the hallmarks of a tax reform bill. Its primary focus is the structure of the federal tax code, as most of the bill is focused on eliminating tax preferences and other tax-driven incentives. However, because the bill also reduces federal revenue by $1 trillion, opponents could argue that such a bill is “really just about cutting taxes, and not about real tax reform.”
Meanwhile, the bill in Example B seems like a straight tax cut. It would lower the federal tax burden on both businesses and households, reducing federal revenue in the process. However, such a bill would still have a profound effect on the structure of the U.S. tax system. The resulting tax code would rely much less heavily on business-level taxes, and many middle-class households would no longer have to file tax returns. As a result, proponents of the bill might still have reason to label their bill a “tax reform” proposal.
Essentially, Example A is a tax reform package, but with a small tax cut thrown in. Example B is essentially a tax cut package, but includes a few elements of reform. Which, if either, of these pieces of legislation deserves to be labeled a “tax reform bill”?
A Taxonomy of Tax Bills
| Keeps Revenue the Same | Lowers Revenue | |
|---|---|---|
|
Extensive Changes to the Structure of the Tax Code |
Definitely “Tax Reform” | ??? |
|
Minimal Changes to the Structure of the Tax Code |
Not a Significant Bill | Definitely “Tax Cuts” |
Most people would agree that a bill that makes extensive changes to the structure of the tax code while keeping revenue constant definitely counts as a “tax reform” bill.[1] Meanwhile, legislation that lowers federal revenue without making significant changes to the structure of the code should probably be called a “tax cut,” rather than reform.
The problem is what to do with bills that fall into the upper-right corner of the chart. After all, in real life, many bills look like a combination of “tax reform” and “tax cuts.” It is common to see tax proposals that make important, fundamental changes to the structure of the U.S. tax code, but also leave federal revenue lower than it was.
One Potential Test
When it comes to tax bills that might or might not count as “tax reform” – those that make structural changes but also lower federal revenue – allow me to propose the following ad hoc test.
To determine whether or not a tax bill should be considered “tax reform,” ask the following: “When you take out the rate changes, what remains?”
To apply this test, start with a tax plan, and ignore all parts of the plan that deal with tax rate cuts. If the remaining portions of the plan add up to a tax code that looks basically similar to the current one, then the bill isn’t tax reform. On the other hand, if the non-rate-related portions of the tax plan make significant and fundamental changes to the structure of the tax code, then the “tax reform” label is probably appropriate.[2]
I think this test works pretty well when applied to the examples above. When you take out the rate cuts from Example A, you’re still left with a bill that eliminates dozens of preferences, reduces several major tax biases, and simplifies the overall code. On the other hand, when you take out the rate cuts from Example B, you’re left with a tax code that looks basically like the one we have now. By this test, Example A should be referred to as a “tax reform” bill, while Example B should not.
The Terminology of “Tax Reform” is Important
Usually, disputes about political terminology aren’t worth wading into, especially when it comes to federal tax policy. It’s too easy to get sucked in to interminable debates about which tax provisions count as “loopholes,” or about whether “death tax” is an appropriate descriptor. Poorly-defined terminology is an inevitable feature of political discourse, and most of the time, it’s more productive to argue about issues than to argue about how we talk about issues.
However, I think it really is worth trying to adjudicate the correct usage of “tax reform.” This is because “tax reform” actually refers to a particular legislative approach for modifying the federal tax code. Not all tax bills are tax reform bills. It is worth trying to use the phrase “tax reform” precisely, so that people don’t become confused about what the approach actually entails.
“Tax reform” is also a term that is particularly likely to be misused by political figures. This is because it has a universally positive connotation; practically everybody claims to be in favor of “tax reform.” Proponents of a given tax bill have every incentive to claim that they are reforming the tax code, while opponents have every reason to argue that a bill “isn’t real tax reform.” In each case, it is worth trying to determine which group is correct.
[1] This test is in no way perfect. In particular, it relies on an ultimately unsustainable distinction between “tax rates” and the “tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. .” For instance, this test would treat a 100 percent exclusion of capital gains and dividends differently than a 0 percent top rate on capital gains and dividends, even though the two policies are nearly identical. That said, I think this test is probably good enough for capturing the gist of most tax plans, in practice.
[2] Some authors argue that, for a bill to count as “tax reform,” it must also be distributionally-neutral, leaving the average tax burden on each income group unchanged. To me, this definition seems much more constricting than the way that “tax reform” is generally used on either side of the aisle. For instance, the left-leaning Institute on Taxation and Economic Policy has argued that “tax reform should increase the progressivity of the tax code.”
Share this article