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Revenue neutral tax reform: A bad goal

Let’s face it, America’s tax system is a mess and is considered by most to be unfair. With justification, tax reform has been a major topic of policymaker’s conversations throughout the Obama administration.

Policymakers and policy analysts, however, generally look back to the last successful tax reform effort in 1986 to get ideas on what makes for successful tax reform. The conclusion all too many have drawn is successful tax reform requires revenue neutrality—reducing tax rates and broadening the tax base. Senate Finance Committee Chairman Orrin Hatch (R-Utah) has advocated for revenue neutral tax reform (which may be a positive step for a member of a party that generally embraces unfunded tax cuts)—it is one of his seven guiding principles for comprehensive tax reform. And President Obama is once again calling for revenue neutral business tax reform in his fiscal year 2016 budget proposal.

{mosads}The idea of revenue neutrality, however, is not only unhelpful to the cause of tax reform but is also dangerously irresponsible. Let me offer three reasons.

First, many tax reform proposals have been introduced in Congress over the past 6 years. Some were favorably received in the tax policy community (for example, the 2010 Wyden-Gregg proposal, and the 2014 Camp proposal), but garnered almost no support from other members of Congress—the 2014 Camp proposal was virtually repudiated by the GOP House leadership on the same day it was released. The business community was, at best, unenthusiastic about the plans. Most of the tax reform proposals were revenue neutral—reduced tax rates would be paid for by eliminating many wasteful tax loopholes.

Revenue neutral tax proposals by definition create winners and losers. The winners would pay less in taxes and the losers would pay more in taxes. The losers tend to be highly concentrated in certain income groups and business sectors, essentially becoming special interests. The Chamber of Commerce noted this feature in its remarks on the Wyden-Gregg tax proposal: “This proposal includes tax increases which are intended to pay for the proposal’s broad benefits but which fall disproportionately on specific sectors, industries, and income groups.” Many of these special interests then make strategic campaign contributions and hire K Street lobbyists to derail the tax reform proposal arguing that tax breaks for some should not come at their expense. In other words, they try to kill tax reform by invoking the “unfairness” argument.

Second, revenue neutrality is harmful given the spending needs of the country. Much has been written on the country’s dilapidated infrastructure—bone-jarring potholes, collapsing bridges, and broken water mains (try driving down K Street in Washington)—that poses dangers to the public and retards economic growth. President Eisenhower argued in 1955 that “our unity as a nation is sustained by free communication of thought and by easy transportation of people and goods” and proposed more federal funding for roads. The argument is as valid today as it was 60 years ago. America also has problems with inadequate funding for education, basic research and development, and other important public investments.

Current federal spending for public investments as a percent of GDP is about half of what it was in the 1960s; average economic growth in the 1960s was double what it has been since 2011 (4.5 percent versus 2.2 percent). Funding these investments would boost economic growth now and in the future. Congress, rather than trying to reduce federal spending to meet revenues, should be raising revenues to meet critical spending needs.

Third, broadening the tax base would make the tax code simpler and wring inefficiencies that hinder economic growth (and inequities) out of the tax code. But keep in mind that broadening the tax base means eliminating tax provisions that would and should be replaced by spending programs. Consequently, revenue neutral may not be deficit neutral—eliminating spending through the tax code that is just replaced by spending will increase budget deficits.

Revenue neutral tax reform should not become a reality; it should not even be under discussion. Tax reform should move forward and perhaps could stand a better chance if the unfairness argument were removed by raising revenue. Revenue positive tax reform will essentially create only “losers”—almost everyone will be paying higher taxes. If everyone pays higher taxes from tax reform, then people cannot justify opposing tax reform on the grounds that their higher taxes pay for someone else’s lower taxes: Congress could be in a better position to resist special interests, who would have to explicitly argue that others should pay even higher taxes so they could get a tax break.

That said, it is also unlikely that revenue positive tax reform will happen anytime soon; I suspect we are in for at least two more years of discussions on tax reform. But if members of Congress were to focus on the benefits of raising revenue to meet critical investment needs rather than worrying about special interests, then, perhaps, bipartisan discussions could begin that will eventually lead to real tax reform where everyone wins (more public investments such as better roads) by losing (paying for it with higher taxes).

Hungerford, Ph.D, is director of Tax and Budget Policy at the

Economic Policy Institute.

Tags Orrin Hatch

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