Why Is Tax Reform So Hard?

COMMENTARY Taxes

Why Is Tax Reform So Hard?

Sep 25th, 2017 3 min read
COMMENTARY BY
Adam Michel

Policy Analyst

Adam N. Michel focuses on tax policy and the federal budget as a Policy Analyst in the Thomas A. Roe Institute.
Special interests and status-quo bias make tax reform difficult. iStock

Key Takeaways

U.S. fiscal policy lacks any sanity. Uncontrolled federal spending has made reasonable tax reform very difficult.

Constant pressure to update the tax code and maintain yearly revenue increases has led many policymakers to search for new or novel forms of additional tax revenue.

Congress should focus on deficit-neutral tax reform. It is possible to both balance the budget and cut taxes by $3 trillion over 10 years.

Republicans campaigned on a promise of pro-growth tax reform. The Congressional Budget Office projects that tax revenue will grow above historical norms for the foreseeable future. In a sane world, this would mean that most taxpayers can expect a sizable tax cut.

Alas, U.S. fiscal policy lacks any sanity. Uncontrolled federal spending has made reasonable tax reform very difficult. On the unreasonable side are those who call for “revenue-neutral” tax reform. That’s simply a call to build tax increases into tax reform. Under what is called “baseline revenues” — revenue projected into the future — tax receipts as a percent of the economy grow year over year, due to real bracket creep and other economic factors.

So when Senate Majority Leader Mitch McConnell (R-Ky.) said tax reform “will have to be revenue-neutral,” what he was really saying was that it will have to maintain those year-over-year tax increases assumed in the baseline. In 10 years, the federal government is projected to collect an inflation-adjusted $1 trillion more than it did last year.

This is all to say that, without reasonable tax reform, federal taxes will continue to consume a growing share of U.S. economic output. Over the last 50 years, revenue as a percent of total output has averaged 17.4 percent. Today, we are about 0.2 percentage points above the historical average. Last year, the federal government collected $74 billion more dollars from the American people than the historical average.

In 10 years, tax collections are projected to be 18.4 percent of output, a full percentage point above the historical average. In 20 years, it will be 19.6 percent — more than 2 percentage points above the average and close to the all-time high.

Tax reform that is revenue-neutral will not reverse the trend of the federal government taking an increasing share of Americans’ hard earned money, year after year. With economic growth from tax reform, the ratio could decrease, but the real dollar tax cost will continue to climb.

Constant pressure to update the tax code and maintain yearly real revenue increases has led many policymakers to search for new or novel forms of additional tax revenue. Some advisors in the Trump administration reportedly entertained, briefly, a carbon tax and a value-added tax — both complex and destructive sources of additional revenue.

The House Ways and Means Committee is still seriously considering a border-adjustment tax that could undermine many of the other benefits from tax reform. Others have proposed raising additional revenue by eliminating the wage deduction for employers.

Each of these proposals allows Washington to continue capturing projected revenue increases into the future, while simultaneously not addressing the true budgetary problem — which is ballooning mandatory spending. Tax reform is imperative, as our current system is economically destructive and outdated. Washington should not tether tax reform to revenue-neutrality.

Most politicos will tell you tax reform is difficult because true reform must take away special tax privileges that benefit well-organized special interests. While partly true, this narrative misdiagnoses the problem.

Tax reform is hard because spending will continue to far exceed tax revenue unless major policy changes are made. Washington has a deficit and debt problem because it spends too much, not because it collects too little in taxes. In fact, Washington is on track to collect well more than half a trillion dollars more per year than they would if government revenue collection just kept pace with economic growth.

In a world of fiscal sanity, Washington would be awash in surplus tax dollars, and tax cuts would be imminent. We do not live in such a world, and those who continually bind tax reform to revenue-neutrality allow policymakers to assume future tax increases and systematically neglect Washington’s spending problem. This view forces Congress to make a false choice between otherwise pro-growth tax reform tied to additional revenue raisers, and no reform at all.

Instead, Congress should focus on deficit-neutral tax reform. It is possible to both balance the budget and cut taxes by $3 trillion over 10 years. This can be done by limiting the assumed increase in federal spending to 2 percent each year — down from the 5.2 percent growth assumed in baseline outlays.

Special interests and status-quo bias make tax reform difficult. But if the U.S. didn’t have trillions of dollars of current debt and growing deficits, tax reform would have been a done deal long ago.

This piece originally appeared in The Hill on 7/24/17