This should be the moment — a reprise of 1986 — when Democrats and Republicans join forces to pass ambitious tax reform.
Proposals to broaden the tax base and reduce marginal rates are suddenly ascendant in Washington, in large part because spending money to stimulate the economy has flopped so spectacularly while adding to the federal debt. Friday’s monthly jobs report had some good news — a small boost in job creation and a slightly lower unemployment rate. But look closer: The total number of working Americans actually fell in July, the average duration of unemployment lengthened, and the number of people no longer even looking for jobs jumped sharply. Add in these so-called discouraged workers and part-timers who want full-time jobs and you get a “real” unemployment rate of 16.1 percent.
Arguably the best tactic now is tax reform — which, of course, to most Americans means lightening their liabilities while sticking it to the other guy or gal. So how are we using the term, and what would it mean for Tom and Tess Taxpayer?
We can reform taxation
As is, the federal government collects more than $1 trillion a year in income taxes — and simultaneously gives taxpayers roughly the same amount in “tax expenditures.” That’s econospeak for tax deductions, credits, loopholes, exclusions — all the ways in which the tax code creates incentives and rewards for politically favored subsets of taxpayers. Conservative Sen. Tom Coburn of Oklahoma has a word for all this: “Tax subsidies,” he says, “are socialism.”
Among the top federal tax expenditures and, ballpark, how much they save taxpayers every year:
*Employer payments for health insurance premiums and other health benefits: $131 billion.
*The home mortgage interest deduction: $96 billion.
*Capital gains and dividends: $80 billion.
*Pension contributions and earnings: $60 billion.
*Earned-income tax credit for low-income taxpayers: $53 billion.
*Charitable contributions excluding education and health: $36 billion.
These tax breaks deplete the federal treasury, penny for penny, just as much as does spending on defense, Medicaid or ethanol subsidies. If Congress and President Barack Obama scaled them back, tax rates could plummet.
Sen. Dick Durbin of Illinois is as liberal as Tom Coburn is conservative, yet when Durbin visited the Tribune editorial board on Thursday, he argued as ardently as Coburn does for tax reform.
Durbin and Coburn served last year on the president’s deficit reduction commission, better known as Simpson-Bowles, and also on the Senate’s rump Gang of Six, another bipartisan effort to address debt and deficits. Both groups discussed trimming tax expenditures and dropping the top income tax rate to perhaps 25 percent.
How does that translate into economic growth? Broaden the tax base, lower the rate, and you’re closer to having market forces — rather than politicians — determine how individuals and companies spend their money. Suddenly they’re investing their resources to gain efficiencies, profits and expansions, rather than tailoring decisions to what the tax code rewards or punishes.
From that new efficiency in the economy will come growth … and jobs. If you’re in the club that thinks the U.S. needs not more taxes but more taxpayers, this brand of tax reform is for you. And if you’re in the club that wants more tax revenues to insulate today’s spending on government programs you like, then this brand of tax reform is for you, too. We’d be fine with a vastly stripped-down tax code aligned to produce more federal revenue — provided Washington uses the extra cash to slash future deficits and existing debt, not to enable still more spending.
The most sacrosanct of these subsidies, the deduction for home mortgage interest, arguably creates the greatest distortions. Not that there’s anything wrong with the government aggressively encouraging people to buy too much house and incur too much debt — is there? We tried to explain other failings of this deduction in a March 23 editorial:
If you rent, you get nothing. If you have reasons not to itemize deductions, you get nothing. If you pay off your mortgage to live debt-free, you get nothing. Borrow a fortune for a McMansion, however, and the Internal Revenue Service provides a big discount, at the expense of every other taxpayer. About three-fourths of the benefit from the mortgage-interest deduction goes to the 14 percent of tax filers reporting six-figure incomes. Almost one-third of the subsidy goes to the population reporting incomes of $200,000 or more.
The leaders of Simpson-Bowles proposed replacing the deduction with a tax credit for 12 percent of interest paid each year on mortgages up to $500,000. That would make a home affordable for Americans who need a modest subsidy. And it would nix the current incentive for wealthier households to take on huge mortgages. A phase-in over, say, 10 years would give Americans time to adjust their finances, and would give the housing market time to adjust, too.
Expect all manner of special interests to fight this, and every other proposed cut in tax expenditures, at both ends of Pennsylvania Avenue. Fair enough. But if all of us have learned anything from the debt-ceiling-and-deficits debate, it’s that we cannot continue a regimen of taxing and spending that requires us to borrow — above and beyond federal tax revenues — $4 billion every day.
Congress has few options for addressing growing economic anxiety. Another stimulus package would smack straight into the new normal: The federal purse is so threadbare that the only way to spend more is to borrow more. That is, borrow even more than we’re already scheduled to borrow over the next decade as we roughly double the national debt owed to the public. And that’s after the debt ceiling deal signed into law last week.
The United States needs a different approach that will streamline the tax code, focus Americans on growth and diminish our indebtedness. Twenty-five years ago, members of Congress from both parties joined with President Ronald Reagan to reform the nation’s tax scheme.
We hope today’s Congress has enough debt realists to do the same with President Barack Obama.
