Tax reform’s hard choices

Republicans and Democrats agree that the federal tax system is broken, but they couldn’t disagree more strongly about how to fix it. That’s true largely because each side clings to a different set of theories about how taxes affect the country, only some of which bear much relationship to reality. Hoping to dispel a few of the myths pervading the debate, a Washington think tank offered a report this week laying out a dozen facts about tax reform. The bottom line: Good fiscal policy comes at a steep political cost.

Because the report was released by the Hamilton Project, an economic policy initiative by the left-of-center Brookings Institution, conservatives may find it easy to dismiss the findings. Nevertheless, there’s ammunition here for policymakers on both sides of the partisan divide. For example, the report notes that eliminating tax breaks for oil companies, corporate jets and corporate takeover artists — three frequent targets for Democrats — would have a trivial impact on the federal deficit.

On the other hand, the report rejects the conservative Republican notion that tax cuts yield so much economic growth that they practically pay for themselves. Rounding up data from all U.S. income tax cuts since the Kennedy administration, the report states that reducing individual tax rates leads at best to modest increases in income, employment and work effort. And when the reductions are financed by more government borrowing (as the tax cuts in 2001 and 2003 were), the data suggest that the economy grows more slowly than it would have otherwise over the long run.

The most commonly touted tax reform these days is one that would lower rates while reducing the number of credits, deductions and exemptions. Such “tax expenditures” not only cost the government more than Social Security, Medicare or defense, the report observes, but they distort the market by favoring selected industries, investments and funding sources.

But many of these tax expenditures were designed to promote things society values, such as health insurance, homeownership and capital investment. And unless policymakers are willing to curtail such popular breaks, they won’t be able to lower rates much without raiding the Treasury. For instance, to cover the cost of lowering individual income tax rates as far as GOP candidate Mitt Romney has proposed, Washington would have to roll back the mortgage interest deduction and health insurance subsidies, raise the tax rate on capital gains and eliminate all itemized deductions.

Romney and President Obama have both spoken blithely about tax reform without specifying how they would accomplish it. The Hamilton Project’s report should make voters skeptical of such promises. Just because the two parties agree that the tax code needs to be overhauled doesn’t mean it will be easy to do so.