October 23, 2005

Tax Reform Do’s and Don’ts

(The following article originally appeared in the October 23, 2005 edition of the New York Post.)

To rally Americans for a radical new tax system, radio host Neil Boortz and Rep. John Linder have written a New York Times bestseller called “The FairTax Book.” It’s more of a campaign document than a tax book, and an ambitious campaign it is: To abolish the IRS and enact a national sales tax to replace income taxes.

So who would collect the taxes if the IRS’s 100,000 employees were suddenly looking for work? The authors envision state tax collectors doing the heavy lifting, collecting the national sales tax along with their own state-level sales — for a piece of the action, of course.

Actually it’s not just the individual income tax that Boortz and Linder would banish but also the corporate income tax, the estate tax and even payroll taxes — both Social Security and Medicare.

They are right on target in their scathing critique of our inefficient income and payroll taxes. Economists of all political stripes make the same charge, accusing our tax system of costing us far more than the money collected — in wasted administrative costs and so-called opportunity costs, the value of all the better mousetraps we’d invent if we weren’t inventing tax shelters. (Full disclosure: the FairTax estimates of tax compliance costs come largely from Tax Foundation, my employer.)

So what about the rate? How high would the FairTax have to be to pay all the same bills we’re currently paying?

There’s the rub.

Boortz and Linder predict that when income taxes are abolished, the price of everything will drop about 22 percent, so it would be fair to replace that revenue with a national sales tax. Prices of most things would allegedly stay about the same.

President Bush’s Federal Tax Reform Panel is about to throw some cold water on that calculation by announcing that the rate would have to be three or four times higher. (The panel’s final report is due Nov. 1.) Since President Bush and several other prominent Republicans have said nice things about the concept, the report will be a bitter pill.

But “The FairTax Book” is prepared for every betrayal. The typically militant member of the FairTax movement (www.fairtax.org) will assail the panel members for being creatures of Washington, who are incapable of thinking and acting radically for the good of the country.

* * *

With nine chapters from tax gurus like Glenn Hubbard, Robert Hall and Joel Slemrod, “Toward Fundamental Tax Reform” separates the tax-reform boys from the tax-reform men. The authors tackle every serious tax plan floated in recent years, including the Hall-Rabushka flat tax, the national retail sales tax, the late David Bradford’s ominously labeled “X tax” and various tweaks of the current system.

Predictably, they disagree on the usual questions: How progressive should taxes be? How much will reform boost growth? What’s politically possible anyway?

Perhaps not surprisingly, those who’ve spent the most time as Washington insiders seem more willing to defend the status quo, while the academic mavericks seem ready to scrap the code and start fresh.

Whatever their differences, the authors agree on three things.

First, the current tax code rewards all the wrong things and wastes a shocking amount of resources. Second, a trifecta of tax crises — the growing AMT, expiring Bush tax cuts and exploding future spending projections — guarantee some sort of tax reform, good or bad. And third, any good reform should include more consumption taxes and fewer income taxes.

Why tax consumption? Several reasons, but one big one is that it lightens the tax burden on capital. And that’s not just good for the wealthy. More capital means workers are more productive, which means the entire U.S. workforce gets a big pay raise.

How big? The book’s editors Alan Auerbach and Kevin Hassett suggest a switch from income to consumption taxes might boost the U.S. economy by a hefty 5 to 10 percent. That’s enough to make the hassle of tax reform worth it.

Unfortunately, much of the book ignores the real problem of tax reform. How can we make it last? Even if we start with a perfect system, what stops Congress from mucking it up over time, as they did with the 1986 reform and all other previous efforts?

Tax handouts are the opiate of the legislator, and any reform that doesn’t shackle congressional access to the tax trough — for example, by requiring super-majority voting on tax changes — is doomed.

Sadly, constitutional restraints on tax handouts won’t happen anytime soon. So ultimately, there’s no need to worry if tax reform stumbles this year. It will surely be back soon.

William Ahern is communications director and Andrew Chamberlain is an economist at the Tax Foundation, a nonprofit tax research group in Washington, D.C.