Recommending tax reform

Bruce Bartlett
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Posted: Aug 02, 2005 12:00 AM

President Bush says he wants to reform the tax system and has appointed a tax reform commission that will issue a report in September. It was originally supposed have finished by July 31, but the White House asked the commission to delay its report so that it would not interfere with the Social Security reform effort, which needs a few more months before it can be declared legally dead.

 When this whole effort started, I said on numerous occasions in columns and interviews that the White House had made a very serious error in attempting to do both Social Security reform and tax reform at the same time. The issues were too big, I said, and it would be lucky if it could do one or the other. Trying to do both ran the risk of accomplishing neither. The delay in the tax reform report shows that the White House has finally started to figure this out.

 We still don't know what the commission will recommend. The assumption has been that it would endorse one or more comprehensive reform options, such as the flat tax or national retail sales tax. However, indications now are that the commission's report may be more targeted and less comprehensive.

 The other week, the tax commission's co-chairmen, former Sens. Connie Mack, R-Fla., and John Breaux, D-La., said that abolition of the Alternative Minimum Tax would definitely be one recommendation sent to the Treasury Department. (Technically, the commission reports to the secretary of the treasury, who will then decide what recommendations to forward to the president.)

 The AMT unquestionably is a very bad part of the tax system and ought to be abolished. But by making this isolated recommendation, it suggests that the commission's report will be less comprehensive than previously thought. After all, if the commission were to recommend, say, a flat tax system, then there would be no need to make abolition of the AMT a separate recommendation. It would be abolished automatically.

 Therefore, I think we may be more likely to get a laundry list of specific recommendations for improving the tax system than a master plan for complete overhaul. The problem with this is that there are any number of reports that have already detailed specific failings of the tax system from the point of view of fairness, efficiency and administrability. They are all gathering dust on library shelves.

 Secondly, trying to do tax reform this way means that the commission must necessarily come up with a list of tax increases to pay for the reforms. The commission is under a mandate to makes its recommendations "revenue-neutral." This means that the package must raise the same revenue as currently projected by today's tax system -- no more, no less.

 It is certain, therefore, that the vast bulk of the public attention will be on the revenue raisers. For example, people are already assuming that the AMT repeal will be paid for by abolishing the deduction for state and local taxes. Naturally, this has high-tax states like New York and California up in arms. In 1986, then-New York Gov. Mario Cuomo, a Democrat, virtually killed this idea single-handedly. This time it could be California Gov. Arnold Schwarzenegger, a Republican.

 The high tax states like the federal deduction because it lowers their tax burden by the amount of one's federal tax bracket. If one itemizes and is in the 33 percent federal tax bracket, then this is like getting a one-third discount on your state and local taxes. Elimination of the deduction, therefore, would constitute a significant tax increase for many people even if they no longer have to pay the AMT.

 In my opinion, these kinds of trade-offs are politically impossible. People will fight much harder to keep a current tax benefit than those who would benefit from a new one will fight for that. Consequently, the only way you can even hope to eliminate "sacred cow" deductions like that for state and local taxes is in a complete overhaul of the tax code. Trying to do it incrementally, as it appears the tax commission is suggesting, is simply doomed to failure.

 Unfortunately, President Bush has never articulated a vision of tax reform, which explains why he is supporting a long list of new tax gimmicks -- I mean incentives -- for energy production and conservation, none of which have any place in a properly designed tax system, from either a liberal or conservative point of view. They just clutter up the tax code and make reform all the more difficult, because you have just created new constituencies in support of the status quo.

 In his new book, "Flat Tax Revolution," magazine publisher Steve Forbes again explains the virtues of fundamental tax reform. I hope someone at the tax commission is reading it.