The Corner

The Fabled ‘Grand Deal’ on Tax Reform

Reuters distributed a dispatch this morning on the politics of tax reform. Why is it proving to be so hard to assemble an effective political coalition for fundamental tax reform like the one Ronald Reagan assembled in 1986? Some reasons offered:

First, glaring loopholes are fewer today; second, the deficit’s size blocks agreement on revenue neutrality; third, Reagan raised corporate taxes, but this is harder now; and fourth, a lower capital gains rate is more deeply entrenched.

Some of the analysts quoted in the story make good points, but for fiscal conservatives there’s an equally important question to ponder: Why didn’t the 1986 tax deal stick? Its top tax rate lasted only a few years, until Pres. George Bush and the Democratic Congress hiked it. Bill Clinton and the Democrats hiked it, again. George W. Bush’s subsequent tax cuts, which liberals describe as an irresponsible giveaway to the wealthy, still left the top marginal rate significantly above the rate Reagan achieved in 1986 through what would supposed to be a grand, historic deal.

Furthermore, looking back on it now, the 1986 tax reform contained grave errors in the tax treatment of investment (via corporate and capital-gain taxes). Those elements deserved to unravel over time. Now most free-market analysts would argue that tax neutrality requires a zero rate on corporate income and capital gains, if income to shareholders and the principal of investments are taxed. Otherwise, you are layering multiple taxes on the same stream of income as it gets hit at the business and personal level and the return on investment is hit at the beginning (by reducing the amount of principal invested) and the end (by reducing the dividends or capital gains earned on the principal).

I would submit that conservatives should be wary of making grand deals on taxes, and opt instead for gradual steps consistent with our overall goals. Grand deals can cost taxpayers dearly in the long run by broadening the tax bases without hard caps on subsequent increases in rates. We are also better off increasing the extent to which voting citizens pay their taxes directly and annually — so they are more likely to know how much government costs them — rather than having them pay indirectly, through corporate income or VATs, and in never-tallied dribs and drabs, through sales tax.

Americans don’t much like paying any taxes, but they are particularly incensed by property and income taxes. Smart liberals know that and figure that hiking state and local sales taxes and creating a new federal VAT will help them drive the overall tax burden closer to the European average. Smart conservatives should not help them.

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