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.”

The Pak Banker - - Front Page - Ezra Klein

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.

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