Why tax reform is so fiendishly difficult in the U.S.
President Donald Trump has been talking about tax reform for months, but true to form, his administration is moving away from a specific proposal, rather than toward one. And that’s fine with Democrats: They’ve just set conditions for cooperating on taxes that are as much about gaining political advantage as advancing the prospects of reform.
What a shame. The U.S. tax system is such an atrocity of self-defeating complexity that it offers enormous scope for improving both fairness and efficiency -- an overhaul that should please liberals and conservatives alike. But to grasp this possibility, both parties need to start looking for ways to agree, not disagree.
The key to this win-win opportunity is simplification. A needlessly complex Tax Code hurts businesses and economic growth, because it makes firms and households worry more about minimizing tax liabilities than maximizing economic gain. But it’s also unfair, because the rich and their advisors can game the system so much more effectively than ordinary taxpayers.
The core of successful tax reform -- last achieved in the U.S. more than 30 years ago -- must be an effort to limit, and as much as possible eliminate, deductions and other preferences from personal and corporate taxes, while using the proceeds to lower tax rates.
This basic strategy could address multiple defects in the current code: unintended spikes in tax rates due to small changes in income; vastly different tax rates paid by companies and households with similar incomes; the subsidy that flows from low-income renters to high-income homeowners with mortgages; the mountain of profits parked in low-tax jurisdictions abroad; the bias in favor of debt finance over equity finance; the carried-interest loophole; and on and on.
The Republicans aren’t opposed to this approach -- they typically pay lip service to it -- but they seem completely incapable of producing a plan. Earlier this year they had one specific idea, to apply so-called border adjustment to corporate taxes, but their latest vapid declaration on taxes withdrew even that suggestion. So they’re back to zero actual proposals.
Senate Democrats, meanwhile, have revealed their rules of engagement for tax reform: They can’t support a plan unless it’s revenue-neutral, avoids cutting taxes for the wealthy, and moves through regular order rather than being fast-tracked to avoid a filibuster. These demands, if offered in good faith, are not unreasonable -- and the Republicans were wrong to reject them. But why set conditions for negotiations at this stage?
In principle, making the Tax Code more fair and efficient isn’t hard. If tax reform fails to happen, it will be partly because of the power of special interests, which jealously guard the status quo. But it will be mostly because of Washington’s dysfunctional parties, which want to embarrass their opponents more than they want to help their constituents.
-- By the editors of Bloomberg News