Last month, “the lobbying floogates“ were opened when the Senate announced that it would look into tax reform and, in particular, it would look to simplify the tax code by eliminating a lot of tax breaks. The endless number of recipients of tax credits are nervous about losing their benefits, and have hired an army of lobbyists to find senators willing to fight to preserve the privileges. The Hill explains:
After years of planning, hired guns for industry are prowling the congressional corridors, going door to door in search of senators who will fight for tax breaks and deductions that are at risk of being wiped from the code.
The stakes couldn’t be higher for K Street firms or their clients, who fear being on the short end if a tax reform bill emerges in Congress — and losing millions of dollars in the process.
“This is and should be the most-lobbied piece of legislation there is because it’s going to have such a broad effect,” said Dorothy Coleman, the National Association of Manufacturers’ vice president of tax and domestic economic policy.
Top Senate tax-writers opened the lobbying floodgates last month when they announced that each of their colleagues should make the case for which tax breaks they think should be inserted back into a stripped-down code.
As the experience of the 1986 tax reform shows, getting rid of tax breaks is a tough exercise, mostly because the people who are benefiting from them don’t want to see them go. My colleague Jason Fichtner wrote an interesting paper about the 1986 process in which he points to some of the positive features of the bill: efficiency, equity, and simplicity. He explains, “TRA86 accomplished all three goals in some measure by reducing the standard rates, increasing the standard deduction, and ending various tax expenditures that distributed resources to less efficient production purposes that sometimes served as the proverbial tax haven.” I should note that the reform was far from ideal, since the lower rates generally were “paid for” with increased double taxation (on capital, for instance). Yet there is no doubt that, even with its problems, it was still a net plus. Unfortunately, it didn’t last. As Fichtner notes:
At the time, TRA86‘s passage seemed like a great success for tax reform. However, looking at the 2011 tax code, taxpayers would be hard pressed to find the aspects of efficiency, equity, and simplicity that were improved with passage of TRA86. The principles embodied in the tax reform of 1986 did not last. Tax reform expert and current Yale University law professor Michael Graetz analyzed the tax code in 2007 and exclaimed the failure of TRA86, noting “The Tax Reform Act of 1986 has not proved a stable outcome: Congress has since narrowed the tax base and raised income tax rates.”1 Additionally, stability can be judged by the number of temporary provisions in the tax code. In contrast to the 25 expiring expenditures in the 1985 tax code, 2010 had over 141 provisions that would expire within the next two years.2 Many of these provisions were renewed again with the passing of the Tax Relief, Unemployment Insurance Reauthorization, and Job Creation Act of 2010.
Making the task of tax reformers more complicated is the fact that, while most tax breaks are nothing more than special-interest politics that should be eliminated in spite of the pressure form lobbyists, this is not always the case. Some tax breaks are meant to alleviate the double or triple taxation of income, and hence, are a good thing. Marking the difference between the good and the bad tax breaks is important. Dan Mitchell has a good analysis about how to think about this:
Ideally, you determine special tax breaks by first deciding on the right benchmark and then measuring how the current tax system deviates from that ideal. That presumably means all income should be taxed, but only one time.
So what can we say about the internal revenue code using this neutral benchmark? Well, there are lots of genuine loopholes. The government completely exempts compensation in the form of employer-provided health insurance, for instance, and everyone agrees that’s a special tax break. There’s also the standard deduction and personal exemptions, but most people think it’s appropriate to protect poor people from the income tax (though perhaps we’ve gone too far in that direction since only 49 percent of households now pay income tax).
Sometimes the tax code goes overboard in the other direction, however, subjecting some income to double taxation. Indeed, because of the capital gains tax, corporate income tax, personal income tax, and death tax, it’s possible for some types of income to be taxed as many of three or four times.
Double taxation is a special tax penalty, which is the opposite of a special tax break. The good news is that there are some provisions in the tax code, such as IRAs and 401(k)s, that reduce these tax penalties.
The bad news is that these provisions get added to “tax expenditure” lists, and therefore get mixed up with the provisions that provide special tax breaks.
I’ve been calling for fundamental tax reform (which includes flatening the tax base but also lowering the rates) for many years, but this is why the recent effort by Senators Max Baucus (D., Mt.) and Orrin Hatch (R., Utah) worries me a little. As you know, the senators want to start with “a ‘blank slate’ — that is, a tax code without all of the special provisions in the form of exclusions, deductions and credits and other preferences that some refer to as tax expenditures.’” The worrisome part is the fact that the senators have explained (in a footnote to the letter they sent to their colleagues) that the Joint Committee on Taxation will be charged with determining what are ”tax expenditures” and what aren’t, which is unfortunate since the group doesn’t make the distinction between the tax breaks that are special-interest tax preferences and the ones that are legitimate. How one defines a tax break matters a great deal, especially if the elimination of ”tax expenditures” isn’t done alongside lowering the tax rates and eliminating the double taxation of income that exists in the current tax code.
The bottom line: Lobbyists will definitely benefit from the recent talks about reforming the tax code. Whether or not taxpayers will benefit too depends on what reform we end up with.