President Obama’s repeated harping on tax loopholes, real and imagined, as part of the debt-limit debate is cause for alarm and hope.
The tax system is rife with tax loopholes, of course. Yet the president appears less interested in tax reform than in building a Trojan horse for tax hikes. To paraphrase Virgil, beware all tax hikers in tax-reformer garb.
And, so far, congressional conservatives have kept guard. As Sen. John McCain, Arizona Republican, recently affirmed, “The principle of not raising taxes is something we campaigned on last November and the results of the election was that the American people don’t want their taxes raised.” True enough. Bravo, Mr. McCain.
Conservatives have even managed to turn Mr. Obama’s ploy into an opportunity for good. As Majority Leader Eric Cantor, Virginia Republican, explained, “If the president wants to talk tax loopholes, we’ll be glad to talk loopholes.” He went on to say, however, that a discussion about closing tax loopholes “should be coupled with offsetting tax cuts elsewhere.” Exactly.
So while the tax-hike alarm has sounded, we ought to nurture real tax reform. The heart of real reform is to pursue one overarching goal, to obey one basic rule, and to follow one simple mantra. The overarching goal is pursuit of a stronger economy. The basic rule is revenue neutrality. The simple mantra is to broaden and correct the base and lower the rates.
For tax reform to succeed, all parties must agree on the goal. The essential goal is to strengthen the economy, which, as Friday’s dismal jobs report underscored, is sorely needed.
The golden rule of tax reform is that tax reformers should not try for more gold. Tax reform must not be used to disguise a tax increase, as Mr. Obama seeks to do. In the first instance, the federal budget problem is an excess of spending, not a dearth of revenues. Further, tax hikes would dissipate any gains toward a stronger economy.
Revenue-neutrality, in turn, means that the reformed tax system should raise the same level of revenues using traditional scoring methods as the current system would raise using current policy.
As the chief goal is to improve economic performance, tax reform’s mantra should be to broaden the base and lower the rates: Eliminate the existing tax bias against saving and investment, eliminate narrowly targeted tax distortions to economic decision-making and to lower tax rates.
Yet not all base-broadening is helpful. Tax policy is as much about what is taxed as it is the rate of tax. Suppose in the extreme case that every dollar earned by a business was subject to tax — no deductions or credits permitted. And suppose every dollar of income, whether wages or capital, was subject to tax without a single deduction, exemption or credit.
Such a tax system would have an enormous tax base, permitting extremely low tax rates. However, lacking a deduction for business expenses, it would impose an enormous bias against investment, while the heavy tax burden on saving would greatly discourage personal saving of all kinds. Violating tax neutrality, the economy would be weaker despite the lower tax rates.
There are many good options for revenue-neutral tax reform that can strengthen the economy. The most comprehensive effective reform is to replace all federal taxes with a simple single rate system that adheres closely to the principles of tax neutrality, as outlined in the Heritage Foundation’s new “Saving the American Dream” plan.
Whether adopted in whole or used as a guide toward a more pro-growth tax system, the plan provides a sound basis for revenue-neutral tax reform.
• J.D. Foster is the Norman B. Ture Senior Fellow in the Economics of Fiscal Policy in the Thomas A. Roe Institute for Economic Policy Studies at the Heritage Foundation (heritage.org).