Cliff Deal May Have Set Back Tax Reform for Good
Business + Economy

Cliff Deal May Have Set Back Tax Reform for Good


President Obama and congressional Republicans are both hyping the chances for tax reform this year, but several signs suggest it’s already time write an obituary for this perennial initiative.

Much of the recent fiscal cliff deal revolved around the tax code, fueling skepticism among economists and budget experts that—despite the rhetoric from lawmakers—an appetite exists for another brutal round of trying to overhaul the IRS’ rules.

“What we did on January 1st isn’t tax reform, but it may well preclude any tax reform for this year,” William Gale of the Brookings Institution told The Fiscal Times. “First, the whole point of tax reform is to reduce the rates and broaden the base. But we just raised the rates. I find it difficult to think that after the election, where Obama campaigned and won on higher tax rates on the rich, that policymakers would then turn around and reduce rates on the rich, even in exchange for a broader base.”

Under the terms of the deal to address expiring tax provisions and automatic spending cuts, federal tax revenues were increased by $620 billion over the next decade by scaling up top marginal rates to 39.6 percent on family incomes above $450,000. The Alternative Minimum Tax was also permanently patched for inflation. All told, the deal affected 84 pieces of the tax code, ranging from tuition deductions to railroad track maintenance to mine safety to algae-based biofuels.

Scott Hodge, president of the Tax Foundation, reacted negatively to a deal that does anything but simplify the tax system. “It really takes us away from reform because it adds so much new complexity to the tax code,” Hodge said in a Podcast for his policy organization. “This is really a setback for tax reform.”

There’s also a legacy of past failures. Last February, the Obama administration unveiled a framework for corporate tax reform. It eliminated loopholes to whittle down the top marginal rate companies pay to 28 percent from 35 percent. But it was met with radio silence after Treasury Secretary Tim Geithner briefed Capitol Hill—and none of the CEOs serving on the president’s Council on Jobs and Competitiveness publicly endorsed the framework.

Still, top Democrats and Republicans say that some kind of reform is possible—even necessary. But they disagree on the basic reason for implementing those reforms.

For Democrats, it is tied to generating more revenue to reduce the budget deficit. Republicans have stipulated that any increase in the government’s borrowing authority—which was breached at the end of 2012 and now settled by the cliff deal—must be accompanied by slashing the government’s projected debt load.

Obama currently refuses to negotiate over the debt ceiling —saying it should simply be raised because Congress already incurred the debt. But he has said that any deficit reduction must stem from both trimming expenditures and limiting tax deductions for the wealthy, a perspective echoed by some congressional Democrats who envision another $1 trillion in revenues over the next 10 years.

“Cutting spending has to go hand-in-hand with further reforms to our tax code so that the wealthiest corporations and individuals can't take advantage of loopholes and deductions that aren't available to most Americans,” Obama said last week when commenting on the cliff agreement.

Progressive groups like Americans for Tax Fairness are planning rallies beginning at the end of the month to push this perspective.

“The Democrats are feeling a confidence on the tax issue that they haven’t felt before,” said Frank Clemente, campaign manager for the advocacy group. “They see it as having been a winning issue electorally.”

By contrast, Republicans seek reforms that are “revenue neutral”—meaning they want to minimize deductions, loopholes and exemptions in order to lower rates. House Speaker John Boehner, R-Ohio, recently described it as a “fairer, cleaner” system that will fuel job creation.

“It isn't a deal or Congress or the White House that necessitates tax reform; it is the weak economy and the outdated, complex and anti-growth nature of today’s tax code that demands it,” Michelle Dimarob, a Republican adviser on the House Ways & Means Committee, told The Fiscal Times.

Michigan Congressman Dave Camp, chairman of the Ways & Means Committee, is fond of complaining that the tax code is ten times the size of the Bible, but it contains none of the good news. He acknowledged on Bloomberg TV last Friday that the home mortgage interest deduction and the exemptions for state and local taxes might need to be limited, but he emphatically said that total revenues won’t inch up any higher post-cliff deal.

“We’ve established the permanent level of revenue the government is going to get,” Camp said. “That’s an absolute in my book.”

GOP lawmakers can claim they’ve already compromised based on tax revenues as a percentage of Gross Domestic Product. Using calculations from the Congressional Budget Office, the cliff deal will cause revenues to climb from 16.6 percent of GDP this year to 19.4 percent in 2022. The House Republican budget had revenues reaching just 18.7 percent of GDP in 2022, while the White House proposal placed them at 19.8 percent.

Obama’s 2010 fiscal commission—led by former GOP Sen. Alan Simpson and Clinton-era White House Chief of Staff Erskine Bowles—submitted a plan that involved genuine tax reform and put revenues at 20.5 percent of GDP in 2022.  But the president and Republican lawmakers alike rejected the plan, which has since become something of a Rosetta Stone for explaining all other proposals to curb the deficit.

But even if both parties agreed on revenues, they would still grapple over which popular deductions—called “tax expenditures—would face the chopping block. The ten biggest tax breaks last year totaled $711.7 billion, according to the White House Office of Management and Budget. Among their contributions to daily life, they subsidized health insurance ($184.4 billion), encouraged home ownership ($98.5 billion for the mortgage interest deduction), aided retirement savings ($67.6 billion), and rewarded charitable giving ($43.1 billion).

The Government Accountability Office issued a report Tuesday comparing them to Medicare and Social Security, two programs that are deemed to be the driver of unstable budgets. “[T]ax expenditures and their relative contributions toward achieving federal missions and goals are often less visible than spending programs, which are subject to more systematic review,” the report said. “One reason for this is that they often operate, in practice, like entitlement programs not subject to annual appropriations.”

Alex Brill, a former policy director for the Ways & Means Committee who is now a research fellow at the conservative American Enterprise Institute, told The Fiscal Times that the odds for tax reform as the best they’ve been in three decades—the last dramatic overhaul was in 1986—because of a willingness to challenge the size and scope of these deductions.

“Republicans are advocating for something that is politically difficult because they believe that the structure of the tax code is as important as the total amount of tax collected,” Brill said.

But being open-minded about reining-in deductions is not the same as putting forth a proposal that would likely produce serious political opposition, said the Brookings Institution’s Gale. And reform is easily doomed by infighting about which tax breaks should be scrapped and which should be safeguarded.

“It is just not clear to me what the base-broadening package would be that would get political support,” Gale said.  “Republicans want to give up on current tax incentives for saving and investment.  And I don’t think Democrats want to give up current tax incentives for health, housing, charity, or state and local governments.  And if you take all of those away, you’ve taken away the major base-broadening opportunities in the tax code.”