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Sisyphus Had it EasyReflections on Tax and Budget ReformThe nonpartisan Urban Institute publishes studies, reports, and books on timely topics worthy of public consideration. The views expressed are those of the authors and should not be attributed to the Urban Institute, its trustees, or its funders. © The Milken Institute Review. Reprinted with permission. Note: This report is available in its entirety in the Portable Document Format (PDF). In the heady days after his re-election, President Bush promised to replace the current tax system with something better. Politicians often delude themselves that reform can be summoned by proclamation. But, a wholesale transformation of the income tax system isn't about to happen quickly or painlessly. In fact, only painstaking bottom-up planning could do the trick. The three major tax reforms since World War II — in 1954, 1969 and 1986 — all required an enormous amount of staff work and Congressional coalition building. And of the three, only the 1986 changes amounted to a true makeover. Since the tax system now affects nearly every facet of American life, hardly anyone likely to pay more goes to the shearing without a bleat. Tax breaks provide indirect subsidies to homeowners that are greater than the entire budget of the Department of Housing and Urban Development. The Earned Income Tax Credit program is now larger than any other welfare program, including food stamps. The break for employer-provided health insurance, currently costing $150 billion per year, is the largest federal health subsidy for the non-elderly and is growing faster than almost all other domestic programs. And then, of course, there are more than half a dozen highly cherished tax breaks for higher education, not to mention preferential tax rates on income received as capital gains. Meanwhile, the average citizen faces an array of tax-based retirement-plan provisions that makes the fabled Clinton health reform plan look simpler than a Starbucks menu. Check that: I meant Starbucks before the latest tax legislation, which grants a tax break to some integrated coffee chains on "the value of roasted coffee beans used to brew the coffee," provided the roasting is done off premises. Real tax reform can't begin until policymakers (or, at least, their staffs) understand the implications of change for everyone from caffeine empires like Starbucks to farmers who make a living selling their corn to make ethanol additives for gasoline. Saying that one is for tax reform is like saying that one is for eliminating wasteful government expenditures; it's just not very informative. Throwing out the tax code may sound fi ne in a sound bite. But policymakers still have to decide what to do with federal programs for housing, work, education, retirement, charity, energy, environment, transportation and all the other policies now largely implemented through the tax code. By the same token, someone still has to decide whether the IRS is going to need employees to rate movies for arousal potential, because Congress has extended the new manufacturing tax break to that vital piece of the industrial heartland known as Hollywood — excluding, "certain sexually explicit productions." Sometimes, reformers can't ignore the implications of tax change, even if they are determined to try. Converting the income tax to a consumption tax, for example, would eliminate special incentives for retirement saving at a time when such saving is one hope of making it through the baby boomers' golden years without bankrupting the Treasury. However difficult and even quixotic, the quest for tax reform must be undertaken once in a while if for no other reason than to keep the arteries of the tax system from becoming hopelessly clogged with preferences. Trouble is, to keep budget deficits within bounds, the public would have to swallow the changes associated with base-broadening and simplification with an even bitterer swig of deficit reduction. Meanwhile, President Bush is attempting to make his previous tax cuts permanent, which implies that any deficit-cutting measures he proposes would suck more cash from fewer pockets. The same can be said of changes required if part of the Social Security tax is redirected into individual accounts, leaving Washington to cover the system's existing liabilities from other sources. The backdrop for reform is even darker. The president and Congress have inherited health care and retirement policies that long ago put government spending on an unsustainable track. The problem is not just that spending on the elderly accelerates in 2008, when the boomers start turning 62; it's also that the growth rate of national income and government revenues can be expected to decline along with the drop in the fraction of adults working and paying taxes. When the boomers are all in their dotage, close to one adult in three will be collecting Social Security. The cost of Medicare, another wide open entitlement for seniors, will grow even faster than Social Security outlays; the new prescription drug program will only add to the budget problem. Exacerbating the fiscal crunch, the last few Congresses went on a giveaway spree like none other in the nation's history. New tax cuts and entitlements, a defense buildup and more spending for farms, highways, workers, doctors, manufacturers and everyone's favorite uncle breezed through Capitol Hill. This rapid, unparalleled growth in commitments from a "conservative" Congress has been the major factor wrenching the federal budget from short-term surplus to yawning deficit — a turnaround of 7 percent of GDP. In the current post-election budget milieu, the powerful push for tax reform that does not affect total revenues can mean much more than simplifying and rationalizing some of the provisions catalogued above. Some want a revenue-neutral reform to further lower tax rates (particularly on investment income) as a matter of economic policy, and competing consumption tax proposals abound. Every special break in the tax code has a private lobby to defend it, not to mention a cheering section within the government bureaucracy.
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