Tax Reform is Very Hard

Recently, we released an analysis demonstrating that it is indeed possible to substantially reduce tax rates while still cutting the deficit. Despite some claims that repealing all tax expenditures could reduce the top rate to only 38% (or by only 4 percent), we showed that doing so would allow the top rate to fall to 23 percent while still allowing for over $1 trillion in deficit reduction. We also pointed to three bipartisan tax plans -- the Simpson-Bowles illustrative plan, the Domenici-Rivlin tax plan, and the 2005 Tax Panel -- which reduced the top rate to 30% or lower while maintaining some support for housing, charitable giving, and savings as well as low-income protections.

On Friday, the Center for Budget and Policy Prorities released its own report arguing that we were somewhat optimistic about how low the rate could get. Though CBPP did not disagree with our findings or dispute our math*, they argued that just because rate-reducing tax reform is technically possible doesn't mean it is politically possible. As they write:

As policymakers assess the import of these analyses, we encourage them to be sure to include one important ingredient: a healthy dose of political reality. A finding that it is technically possible to achieve sufficient tax-expenditure savings to pay for sizeable reductions in tax rates is not the same thing as such a course being politically viable. Policymakers should avoid committing to a specific, lower top income tax rate until they know what measures to shrink tax expenditures Congress can actually pass and how much savings those measures will produce. Otherwise, the most critical goal of tax reform at this time — producing a significant contribution to deficit reduction (while maintaining or improving the progressivity of the tax code) — will likely be lost.

CBPP's analysis is certainly worth a read, as it provides important details on something we've been saying for quite some time: tax reform is really hard. To both reduce deficits and marginal tax rates, policymakers will have to make a number of very tough choices -- including repealing or reforming tax preferences which may have important purposes and certainly have strong political constituencies. Substantial rate reduction may also require going after some tax expenditures which may be administratively tough to eliminate, in some cases adding to the compliance burden of the tax code (while reducing it in other ways).

Yet while fundamental tax reform is quite hard, its potential benefits are large enough that we believe it is at least worth pursuing. Done right, tax reform could improve incentives to work and invest, reduce allocative distortions, increase progressivity, make the tax code fairer and simpler, and raise revenue to help reduce the deficit. By leading to faster overall economic growth, such a reform could be an important part of a "go smart" strategy to reduce the deficit.

To be sure, achieving all the goals above will be incredibly difficult. But that isn't a reason for policymakers not to try and achieve comprehensive and sweeping tax reform. Even tax reform which falls short of the ideal could still be a substantial improvement over the current tax code or over a code which raises new revenue from rate increases alone.

CBPP makes a very good point that rate reduction should not come before deficit reduction and that politicians should not lock themselves into more rate reduction than what they are willing to finance (including the costs of reducing the deficit). The benefits of tax reform, important as they are, would be more than offset by the economic cost of failing to deal with our mounting debt.

Policymakers must not lose sight of the need to reduce the deficit, so it must be the priority when it comes to taxes. But ideally, they would also make the hard choices necessary to reform the corporate and individual tax codes and make them more efficient.

You can find our analysis JCT's tax experiment here.

*CBPP does warn that our revenue estimate from repealing the exclusion for employer provided health insurance may be too high if we do not take into account the increased costs to Medicaid and the exchange subsidies from people moving out of employer coverage. In fact, we do attempt to account for this cost by very roughly assuming that the net savings from repealing the exclusion will only be 75% of what it would be absent the existence of the Affordable Care Act.