Right on Track

Posted: May 01, 2001 12:00 AM
Like many conservatives, I have become increasingly impressed with the Bush administration's sophistication in pressing conservative reforms. Oftentimes, the things I am most impressed with are in subtle "inside the beltway" areas outside the view of voters and even the media. I discovered a recent example of this recently while reading the administration's 2002 budget. To be sure, actually reading a budget is just about the most boring thing anyone can possibly do. But sometimes the effort is rewarded, when one finds a nugget of undiscovered information. Such material is seldom highlighted and may not even be visible except to those of us who have slogged through previous budgets. Simply using new rhetoric to replace boilerplate language from earlier years may indicate fundamental changes in philosophy, with long-term consequences. An example of this appears in the budget volume titled, "Analytical Perspectives." There, one finds a chapter on "Tax Expenditures." This refers to provisions of the tax law that lower revenue from what would be the case under a "normal" tax system. In practice, tax expenditures are treated as unjustified provisions of the Tax Code that ought to be eliminated, at least in principle. The tax expenditures concept was created by Stanley Surrey, a longtime Harvard law professor who served as assistant secretary of the treasury for tax policy throughout all of the Kennedy and Johnson administrations. Surrey was very liberal and concerned that the high tax rates of that era -- which went up to 70 percent -- were seldom actually paid because of "loopholes" in the law. He wanted to abolish these provisions and force people to pay taxes at the high rates they ought to be paying. Surrey's plan was to stigmatize what he viewed as loopholes and publicize them, in the hope that this would lead Congress to abolish them. He spent 8 years working toward this goal but was not successful until his last year in office. Only in late 1968, after the election of Richard Nixon, was he able to get the Treasury Department to publish a list of tax expenditures and propose legislation to restrict them. Unfortunately, the Nixon administration went along with Surrey's idea and not only endorsed the tax expenditures budget, but signed into law the Tax Reform Act of 1969, which sharply raised taxes and contributed mightily to the economic malaise of the 1970s. For example, this legislation scaled back the exclusion for capital gains, one of the most notorious tax expenditures. This led to a sharp cutback in capital investment -- especially in risky areas such as high technology -- and slower economic growth. Later, Congress codified tax expenditures in the Budget Act of 1974. Subsequently, whenever there was a need to raise taxes, both Congress and the administration tended to turn to this list for likely suspects. The problem is that the notion of tax expenditures is fundamentally flawed, because the decision to list one provision and not another essentially is arbitrary. This is shown by the fact that the Treasury Department and Congress' Joint Committee on Taxation, which use the same underlying definition of a normal tax system, cannot agree on what is and is not a tax expenditure. Also, the list changes from year to year. Moreover, both use a definition of income as a reference that is not by any means universally accepted among tax theorists. Many believe that a consumption base, rather than an income base, is more appropriate for taxation. If this is the case, then many items from the tax expenditures list would simply disappear. For example, any provision that exempts taxes on saving, such as IRA's and 401(k) plans, would not be considered a tax expenditure if consumption is assumed to be the proper or normal tax base. As noted earlier, the Nixon administration could have killed tax expenditures in the crib, but instead it endorsed the idea. This led to many very counterproductive tax changes in future years, such as raising the capital gains tax and made it harder to implement positive tax changes, such as expanding IRAs and 401(k) plans. No subsequent Republican administration, even Ronald Reagan's, made any effort to curtail the use of tax expenditures, despite the bias it creates in favor of liberal tax policy. Now, however, there has been a change. President George W. Bush's first budget assaults the tax expenditures concept in a subtle, yet profound way. It is already causing deep consternation among liberal tax advocates. In his budget, Bush denies the very legitimacy of tax expenditures. The budget refers to them as "so-called tax expenditures." It goes on to say that the administration considers the concept of tax expenditures to be "of questionable analytic value." The budget explains that tax expenditures are based on an "arbitrary tax base." Therefore, the question of what is and is not a tax expenditure "is a matter of judgment." It goes on to identify some specific problems with the way tax expenditures historically have been presented: Tax deferrals on income that will ultimately be taxed in the future are treated the same as tax exemptions -- income that will never be taxed. And the corporate income tax is treated as a normal feature of the Tax Code, even though the underlying concept of income used to calculate tax expenditures views it as an improper double tax on corporate profits. (They are taxed once at the corporate level and again when paid out to shareholders.) Perhaps most importantly, the budget introduces for the first time the concept of "negative tax expenditures" -- provisions that raise taxes above that of a normal tax system. These include provisions that are not adjusted for inflation, such as depreciation allowances. The Bush administration's approach to tax expenditures is both welcome and sophisticated. Proof of this is that the new presentation has already been blasted by the liberal Center on Budget and Policy Priorities. From the point of view of conservatives, this is proof that the administration is on the right track.