Time For Bi-partisan Consensus on Tax Reform

December 13, 2006

Two former communications directors at OMB, one for Bush II and one for Clinton, argued for bi-partisan tax code reform this week in the Baltimore Sun.

Noam Neusner and Lawrence J. Haas said the time is ripe for a consensus that would lower federal income tax rates and broaden the tax base.

Politically, tax reform would broaden the budget debate. By promising lower tax rates on a broader base of income, tax reform would enable Congress to eliminate special-interest tax provisions that lawmakers would more likely protect as part of the annual budget process – things like write-offs for domestic manufacturing or for farming as a hobby.

And then there’s the policy benefits. Tax reform can unlock a lot of good ideas.

On Social Security, tax reform could mean lowering tax rates on worker wages – a plus for conservatives – while raising the current threshold of just under $100,000 on wages subject to taxation – a plus for liberals. The resulting increase in total Social Security revenues could close the funding gap for future benefits – a plus for everyone.

On health care, tax reform could lower the deductibility of health insurance benefits, which appeals to conservatives, while also appealing to liberals by raising funds to bolster Medicare’s long-term solvency.

Congress could use tax reform to pursue a bolder path: Reduce our reliance on the income tax and create a consumption tax. That would please conservatives who believe a consumption tax would spur savings and investment, as well as liberals who think the nation needs more revenue to strengthen Social Security and Medicare and address other priorities.

Putting the merits of a consumption vs. income tax aside, there are enormous benefits to broadening the tax base. For starters, it would create horizontal neutrality, meaning those with similar incomes would pay roughly the same in taxes. Doing so reduces the inequity of giving tax credits to some and not to others. It also promotes efficiency in the economy because people will make economic decisions based on choice and preference, not tax benefits. That leads to greater social welfare.

Second, people will pay their taxes if the system is perceived to be simple and fair. Preferences complicate an already complex system which discourages people from filing their taxes. The Tax Foundation calculates that criminal evasion reduces the tax base by eleven percent – roughly the same amount as credits and exemptions combined. Credits generally benefit those that are politically favored which adds to the notion that some are being unfairly taxed. Efforts to mitigate the unfairness create a downward spiral of more credits and deductions that ultimately make the code less simple and less fair.

Last, any effort by the new majority in Congress to ensure ethical behavior amongst its members must address the giveaways and preferences that are the catalyst for many of the violations. Spending limits on lunches, gifts and “junkets” simply won’t do. Credits on the tax side that favor specific industries are no different than showering those industries with pork on the spending side.

Neusner and Hass are correct that the time is right for tax reform. It is now up to our lawmakers to take this opportunity to do the right thing before it is lost.

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