The Emerging Intra-Democratic Tax Reform Split

by Reihan Salam

Though Keith Hennessey is hardly optimistic about the prospects for tax reform, he sees the potential for a bipartisan tax reform compromise between Rep. Dave Camp (R-MI), who has been distinguishing himself, and Sen. Max Baucus (D-MT), provided both legislators are able to resist the push from the Obama administration and Sens. Patty Murray (D-WA) and Charles Schumer (D-NY), who are pushing for an approach that would likely little if any Republican support. Keith is unsparing in his characterization of the president’s approach:

I think Sen. Schumer [and President Obama] wants the Senate to pass a tax bill that raises aggregate taxes and moves tax policy pretty far to the left. For individuals this would mean different tax preferences based on a taxpayer’s income as well as higher capital gains and dividend tax rates. For firms it would mean higher total corporate taxes, higher taxes on flowthrough businesses (subchapter S firms, LLCs, limited partnerships), and a move toward worldwide taxation of overseas income for C corps. Corporate tax rates would vary based on the type of business—higher for the major oil companies, lower for renewable energy firms and high-tech manufacturing. The tax code would become [even more of] a vehicle for industrial policy and the higher total taxes would finance continued increases in government spending.

Tax reform has traditionally meant broadening the tax base and lowering rates and reducing economic distortions by creating more horizontal equity in which taxpayers in similar situations are treated the same by the tax code. In the Schumer[/Murray/Reid/Obama?] view a new tax bill would introduce as many new tax preferences as it eliminates, it would favor certain industries and firms over others, and it would finance more government spending. That is not tax reform, that’s liberal tax policy labeled as tax reform.

The question for Republicans, however, is whether they can make an effective political case against a tax code revamped along these lines, particularly if we assume, as seems likely, that most middle-income households will be shielded from its direct, if not its indirect, consequences. CAP’s tax reform proposal, for example, envisions a modest cut in the income tax burden for households earning less than $100,000, which accounts for the vast majority of voters. Yet the CAP proposal also sharply increases capital income taxation, among other things. The former might neutralize the latter, unless Republican legislators offer a compelling rebalancing of the tax burden of their own, e.g., away from the implicit investment households with children make in the future stock of human capital and towards the consumption of childless high-earners living in high-tax jurisdictions. My guess is that Keith wouldn’t be amenable to this approach, as it does entail a departure from strict horizontal equity, e.g., a household earning $75K with three children will pay substantially less than household earning the same amount, but with no children. But it is an approach that has substantive as well as political virtues.