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Three Things We Need on Taxes: Simplify, Simplify, Simplify

By Maya MacGuineas
Director, Fiscal Policy Program, New America Foundation

Los Angeles Times
February 11, 2001

George W. Bush could greatly improve his $1.6-trillion tax-cut proposal by combining it with an issue that has been absent from recent political discourse: tax reform. By taking the lead on reform, Bush could capitalize on dissatisfaction that transcends party lines and alleviate the burdens on the nation's 128 million taxpayers.

As frustrated taxpayers have noticed, the tax code has become vastly more complicated in recent years. One of President Bill Clinton's defining discoveries was that he could work more harmoniously with Republicans by packaging domestic policy initiatives as tax cuts instead of new spending, turning the tax code into a jackpot for giveaways. New child care, education and retirement policies became targeted tax cuts. (Targeted tax cuts are the ones that start with if, as in if you meet certain criteria or if you spend in certain ways, you pay less.)

Over the past eight years, these tax breaks popped up everywhere. New breaks were extended to parents of freshmen and sophomores in college, residents of declared disaster areas, farmers who were forced to sell livestock because of bad weather conditions, mail carriers in rural areas and federal employees engaged in criminal investigations who must travel away from home, to mention only some. This barrage of deductions and credits brought to the tax code a whole new level of complexity. Federal tax laws and regulations now consume more than 46,000 pages, with plenty of loopholes for individuals and corporations that can afford the services of clever accountants.

Targeted tax cuts have been the undoing of the progress that was made in the tax reforms of 1986, which broadened the tax base and lowered rates, two goals that still make sense. By furtively slipping tax breaks into the code, the country is denied the important debate over the nature, purpose and extent of child care or education policies, as well as what role the government should play in providing these services.

Bush, then, should incorporate into his tax cuts a plan that would return the tax code to something a person without a Caltech PhD could decipher. He could, for example, adopt the still popular and sensible goals of broadening the tax base and reducing rates. Streamlining the tax code, which is riddled with targeted tax relief and phase-ins and phase-outs for eligibility, would broaden the base by $ 200 billion to $ 400 billion a year, allowing tax rates to be reduced by far more than he currently proposes. Favoritism for certain groups, subsidized by others, would be eliminated. Even under a revenue-neutral plan, in which tax rates were lowered just enough to offset whatever tax breaks were removed, people would save because it would be easier--and cheaper--to prepare their tax returns. In a country that spends between $ 100 billion and $ 200 billion a year on federal tax compliance, simplicity would offer substantial savings.

Lawrence B. Lindsey, now Bush's chief economic advisor, concluded in a 1997 policy piece, published by the American Enterprise Institute, that "a broad-based income tax with a flat rate in the low 20s and a generous exemption amount may well be on the table after the next presidential election." While a flat tax is not likely, the influential Lindsey will have ample opportunity to make his case for simplicity and lower rates.

Or Bush could go further, addressing not only convoluted tax laws but dwindling savings rates. Personal savings rates have declined significantly from 9% in 1992 to almost a negative 1% in 2000. While new investment in the stock market has grown, this has been more than compensated for by an even greater level of borrowing. Not only is the propensity of individuals to spend rather than save worrisome, in that it heightens the risk of unmanageable debt and personal bankruptcies, but it is a drag on the economy, which needs savings and investment to grow. Switching to some form of consumption tax would alter the tax code from one that penalizes earnings to one that creates incentives to save, leading almost certainly to higher economic growth.

Still, many of the policies that have been considered to promote savings have been rejected because they are regressive, hitting the poor the hardest. Switching from an income tax to a sales tax or exempting all savings from taxation would accomplish the goal of increasing savings, but it would do so by reducing taxes for those who buy luxuries they can afford to do without. While someone earning $ 250,000 a year has a choice about how much to save, a person earning $ 25,000 may not have many options to scale back consumption. Assume a 20% consumption tax replaced the current income tax. A $ 25,000 earner who saved $ 500 would owe $ 4,900, or 19.6% of his or her income. A $ 250,000 earner who saved $ 50,000 would owe a lower 16% of income, paying $ 40,000 in taxes. The last thing Bush needs is another accusation that his proposals benefit only the wealthiest taxpayers.

A fairer approach that would offer simplicity and help build savings would be a progressive consumption tax. Such a tax is similar to the income tax in that it uses progressive rather than flat tax rates, but with the distinction that taxes are based on spending rather than income. Individuals would subtract what they saved from what they earned in a year and be taxed on only their spending, at rates that increased with their levels of consumption. Take for instance a plan with no tax on the first $ 20,000 of consumption, 25% on the next $ 70,000 and 35% on everything spent beyond $ 90,000. Under such a tax, the same $ 25,000 earner who saved $ 500 would owe $ 1,125 in taxes, 4.5% of his income. The $ 250,000 earner who saved $ 50,000 would owe $ 56,000 or 22% of income. Within any income category, those who saved more would pay less. A progressive consumption tax would effectively create incentives to save, but also recognize that wealthier individuals can afford to save more.

By proposing tax reforms, not just cuts, Bush could start off his presidency with an agenda that would be far more compelling than his current plan, which does nothing to improve the fairness, simplicity or incentives built into the tax code. By championing tax reform, he would attract new support from both parties and the public. By developing a plan with input from Republicans and Democrats along the way, he would increase the likelihood of its success. If Bush were to reform the tax code in a manner that increased national savings, the economy would prosper, benefiting his administration, just as Clinton's benefited from the elimination of the deficit. And by maintaining the progressive elements of our current tax system, he could shed allegations that his plan mainly benefits the wealthy.

Finally--something that too often gets lost in political calculations--reforming the tax system in a way that increases simplicity and rewards savings is the right thing to do.

Copyright: 2001 Los Angeles Times

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