The Senate and House of Representatives both have passed budgets that represent the preferences of the majority party in each chamber. Now it’s time to agree on a plan that can attain support from both parties.
Tax reform can be the key that unlocks the puzzle.
On Wednesday, President Obama released a budget request that offers some entitlement savings in exchange for additional tax revenue.
While many assume that getting an agreement on additional revenue is impossible, reform that cleans up the tax code, makes it more efficient and enhances competitiveness — along with significant structural entitlement reforms — could provide the breakthrough we need for a plan that addresses long-term national debt while promoting economic growth. That is a lot of pressure for an undertaking that is both desperately needed and treacherously complicated.
There is support in both parties for reforming the more than $1 trillion a year in tax deductions, exemptions and other loopholes known as “tax expenditures,” which are essentially spending through the tax code.
Many of these tax expenditures are only enjoyed by select taxpayers and distort the economy by disproportionately benefiting some activities, companies or industries over others. We can both reduce tax rates and the deficit by eliminating, limiting or reforming these loopholes that adversely affect the budget and the economy.
The Simpson-Bowles debt commission illustrated one way to deal with tax expenditures: Its plan outright eliminated most expenditures and reduced tax rates to much lower than they are today.
If lawmakers want to reinstate a tax break, they would have to pay for it by buying the rates back up. I love this approach and would hope lawmakers would have the fortitude to start with a clean slate and limit the number of tax breaks they layered back in. But the political pressure to protect and preserve every single tax break would be mind-boggling.
The home mortgage interest deduction pushes housing prices up, and it subsidizes the lending and building industries. And the healthcare exclusion is a major contributor to escalating healthcare costs. But people love their tax breaks — the industries that benefit love them even more — and there is real cause for concern that the massive lobbying effort to preserve these breaks could derail tax reform entirely.
Another approach designed by myself, Marty Feldstein and Daniel Feenberg of the National Bureau of Economic Research, which would cap tax expenditure benefits at a set level of household income, might be more politically plausible. The advantage of this approach is that it eliminates the haggling over which tax expenditures to keep, which should make this reform easier to enact, given the political realities we face.
The Feldstein-Feenberg-MacGuineas tax expenditure cap represents a straightforward way to limit tax breaks. You basically set the limit that no taxpayer could have more in tax breaks than a percentage of his or her income (we generally assume 2 percent, but this could vary) and then don’t have to pick and choose which of the existing tax breaks to eliminate.
This approach has the potential to raise hundreds of billions or even trillions of dollars over a decade, generating revenues that can be used both to bring tax rates down and reduce the deficit. It meets a general test of fairness that some people should not benefit disproportionately from the tax code as they do now. Additionally, it can be adjusted in several ways to make it more progressive or meet a variety of different tax objectives, such as by altering which tax breaks are included in a cap.
Thankfully, tax reform appears to be moving forward this year. Senate Finance Committee Chairman Max Baucus (D-Mont.) and House Ways and Means Committee Chairman Dave Camp (R-Mich.) have been preparing for over a year to rewrite the tax code. The bipartisan, bicameral duo is committed to fundamental tax reforms and the lawmakers are closely coordinating with each other.
The support and cooperation of the leaders of the congressional tax-writing committees is a positive sign that tax reform can happen.
Agreeing on tax reform that relies on a tax expenditure cap could help pave the way for a comprehensive agreement to alter the unsustainable trajectory of our national debt. Hopefully, such an approach could open the door to a truly bipartisan, comprehensive deal.
