Understanding Tax Reform Madness

I don't think it was his intention, but NYT columnist Bruce Bartlett has put together a few points on why tax "reform" is a joke and he destroys the myth that Ronald Reagan was a tax cutter.

On Reagan, he writes:

In his 1984 State of the Union address, President Ronald Reagan asked the Treasury Department to study tax reform and send him a report on options. The task fell largely to Eugene Steuerle, then a Treasury economist and now a senior fellow at the Urban Institute in Washington.

The Treasury approached the project with an open mind....The report was not a call for tearing up the tax code and starting over from scratch. It was about taking the tax system as it was, fixing glaring problems and proposing improvements that were doable, rather than pie-in-the-sky reforms with no chance of enactment.

Two key constraints guided the Reagan tax reform effort. First was a hard revenue-neutrality requirement. Because our political leaders actually cared about the budget deficit in those days, a tax cut was not viable; any proposals that reduced revenue had to be offset by provisions that raised revenue. The final package was devised to neither raise nor lower aggregate revenues.

In short, Reagan was not about tax cuts, he was about rearranging taxes. He taxed, your shoes, say, instead of your socks.

Murray Rothbard had it right about Reagan all along, when he wrote in 1987:

One of the few areas where Reaganomists claim success without embarrassment is taxation. Didn't the Reagan administration, after all, slash income taxes in 1981, and provide both tax cuts and "fairness" in its highly touted tax reform law of 1986? Hasn't Ronald Reagan, in the teeth of opposition, heroically held the line against all tax increases?

The answer, unfortunately, is no. In the first place, the famous "tax cut" of 1981 did not cut taxes at all. It's true that tax rates for higher-income brackets were cut; but for the average person, taxes rose, rather than declined. 

The highly ballyhooed Tax "Reform" Act of 1986 was supposed to be economically healthy as well as "fair"; supposedly "revenue neutral," it was to bring us (a) simplicity, helping the public while making the lives of tax accountants and lawyers miserable; and (b) income tax cuts, especially in the higher income brackets and in everyone's marginal tax rates (that is, income tax rates on additional money you may earn); and offset only by plugging those infamous loopholes. The reality, of course, was very different, In the first place, the administration has succeeded in making the tax laws so complicated that even the IRS admittedly doesn't understand it, and tax accountants and lawyers will be kept puzzled and happy for years to come.

Rothbard nailed it. Check out how mad this tax "reform" actually was  and how it often led to unexpected (by the interventionist tax designers) all kinds of distortions in the economy. Here's Bartlett:

...the 1984 effort necessarily needed to be bipartisan from the beginning, and it was. The chairman of the House Ways and Means Committee, Dan Rostenkowski of Illinois, accepted the need for tax reform and was instrumental in moving the ball forward.

For several months after the Treasury study was published, the White House reviewed its options. In May 1985, it sent a detailed tax reform proposal to Capitol Hill. It incorporated some valid criticisms of the Treasury effort and deleted some of the more politically controversial ideas. This proposal formed the basis of the Tax Reform Act of 1986.

One lesson of that effort is that it is very, very easy for tax reform to lose its focus absent a detailed outline at the start of the process. Vague principles are insufficient to guide legislation, because it’s too easy to ignore and jettison the unpopular revenue-raising side of the coin — the actual reforms — and just do a bill loaded with special-interest provisions enacted at the behest of tax lobbyists.

Also, given the long road to tax reform from the Ways and Means Committee to the House floor, to the Senate Finance Committee, to the Senate floor, to a conference committee and final passage, many opportunities abound for squeaky wheels to demand their pound of grease.

It is essential that there be some baseline against which to measure progress and experts following it closely enough to know when some seemingly innocuous amendment will interact badly with some other provision to create a perverse result.

Even with the Treasury keeping a close eye on the progress of the Tax Reform Act of 1986, mistakes were made. A glaring one was the provision eliminating the deduction for interest paid on credit cards and other consumer loans. The idea was to curb borrowing for consumption while raising revenue to pay for revenue-losing provisions of the legislation.

However, ending the deduction for consumer interest neither reduced consumer borrowing nor raised revenue, because mortgage interest remained deductible. Banks simply created home-equity loans to finance consumer borrowing and the interest remained tax deductible. By and large, such loans simply replaced those that the Tax Reform Act tried to curb.

Arguably, the result was worse than doing nothing. Excessive credit card debt can be renegotiated or discharged through bankruptcy. But when people start using their homes as credit cards, the results can be more severe. Any downturn in home equity, especially a prolonged one such as we have seen since 2007, risks the loss of people’s homes when home equity loans cannot be paid.

So what lesson does Bartlett suggest has been learned from the Reagan mess? That the reform is a joke, that taxes don't come down, that distortions occur? Nope.

Bartlett writes:

President Obama should have taken a page from Reagan’s book and asked the Treasury to do another comprehensive study of the tax system...It would have been better to approach tax reform in a comprehensive manner, as the Reagan administration did in 1984.

And there you have the mind set of a DC insider. Never real reform. Never real tax cuts. Just jiggle the system and make it look like you are doing something serious and important. Amazing.