Tax reform won't save world
“It will support economic growth, which means more revenue is generated for the Treasury. And it will improve the efficiency of the system, which means additional revenue as well.”
WASHINGTON loves its panaceas. A few years ago, it was Army General David Petraeus who could fix any problem up to and perhaps including the presidency. Then it was the Simpson-Bowles commission, or maybe the congressional supercommittee on deficit reduction. Today's cure-all? Tax reform. Tax reform "will result in the additional revenue the president seeks," said House Speaker John Boehner in his post- election news conference. "It will support economic growth, which means more revenue is generated for the Treasury. And it will improve the efficiency of the system, which means additional revenue as well." He went on to quote former Treasury Secretary George P. Shultz, who said the 1986 tax reform was "the unsung hero of the very good economic times we had for a long time."
That's the Washington consensus on tax reform: It slices, it dices, it cleans up after itself. But that's not the economic profession's consensus.
In 1997, Alan Auerbach and Joel Slemrod conducted an exhaustive survey of studies conducted after the 1986 tax reform. The results were mostly disappointing. The strongest effect they found was in "the timing of economic transactions" - - for instance, the rush to take capital gains before a new, higher rate kicked in. After that, it was "financial and accounting responses," such as the effort to transform corporate income into individual income in order to, again, avoid higher taxes. All this is good news for tax lawyers, but what about moving the growth needle?
"At the bottom of the hierarchy is the response of real activities chosen by individuals or firms." On this, the authors concluded, the evidence is "mixed." Oh.
Over the past week, I've asked a dozen economists whether tax reform is likely to supercharge or even kind of charge growth.
The consensus is summed up well by former White House economic adviser Lawrence Summers: "Given there's a need to raise revenue, doing it by closing loopholes is probably a better way to do it than doing it by raising rates," Summers said.
"It can promote fairness, simplicity and resistance to special interests. But the idea that this is some important offensive growth strategy is implausible."
Bruce Bartlett, who helped write President Ronald Reagan's 1981 tax plan, is even more emphatic.
"I am not familiar with any tax reform that raised growth, here or anywhere else," he said.
Some kinds of tax reform could raise growth, at least in theory. Additional research by Auerbach, for instance, sug- gests that a sharply regressive consumption tax could add as much as 4.5 percent to gross domestic product over 15 years, in part because of the labor market effects of cutting taxes significantly on the rich and raising them on the poor. But no one is advocating that.
Instead, Washington policy makers are debating an approach broadening the tax base through closing tax expenditures, credits and deductions that isn't likely to do much at all.
Tax economists Alex Brill and Alan Viard put the problem clearly in a brief for the American Enterprise Institute: "One of the major arguments some supporters of base broadening make - - that such reforms reduce work disincentives is generally mistaken. Work incentives depend on effective marginal tax rates rather than statutory tax rates, and revenue-neutral base broadening leaves the former roughly unchanged."
Translated from tax policy-ese, the basic point is that if you're not cutting total taxes the "effective marginal tax rate" you're not going to drastically alter the incentives people have to work.
As a result, you're not going to see much added growth from tax reform, especially if the revenue contributed by various groups remains largely unchanged.
All that should be pretty intuitive; if you're not changing who pays taxes or how much they pay, you're not changing all that much. Simplifying the tax code only gets you so far. However, if Republicans and Democrats can agree on tax reform, it almost certainly will do more than simplify the code. It will increase taxes on the rich.