An opportunity for tax reform?

Douglas Holtz-Eakin Former Director, CBO
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With the announcement of six Republicans (Reps. Paul Ryan, Dave Camp, and Jeb Hensarling and Sens. Judd Gregg, Tom Coburn, and Mike Crapo), the lineup for President Obama’s National Commission on Fiscal Responsibility and Reform is set. While the commission will more likely feature show over substance, it also might be an opportunity to move forward on much-needed tax reform.


It is inevitable that talk will quickly turn to the “need” to raise taxes, and Democrats will likely offer up the president’s proposal to let the tax cuts sunset for the top two brackets. However, the idea that we can get close to balancing the budget merely by increasing taxes on the rich is risible. Using the administration’s own baseline, the non-partisan Tax Policy Center has calculated that the top two rates will have to be 91 percent and 86 percent, respectively, to bring the deficit down to average 2 percent of GDP over the 2015-2019.

One does not have to be a raving supply-sider to recognize that tax rates that high are well past the peak of the Laffer curve, deeply unfair and economically damaging. In short, the leading tax policy position is a non-starter. Indeed, the TPC shows pretty clearly that focusing on taxes alone is badly misplaced. If every tax rate were to be raised, the rates would range from 15 to 52 percent, up from 10 to 35 percent at the present.

The commission should focus like a laser beam on federal spending. It is the cause of the budget woes and continues to get more out of control after 2019.

Despite this, Democrats will insist that taxes be front and center. Given this reality, Republicans should counter the idea that the top two rates be allowed to sunset with the proposal that all tax cuts sunset, including both the 2001 and 2003 Bush-era tax cuts and the 2009 Obama “stimulus” tax cuts. After all, liberals have argued again and again that the tax code of the 1990s was why the economy grew and the middle class prospered. If the argument is that we should turn the clock back, then it should be turned back completely. Right?

Democrats will howl at the loss of the 10 percent bracket, the expanded Earned Income Tax Credit, marriage penalty relief, the and myriad other provisions enacted in 2001 and 2003—thereby exposing their hypocrisy on tax matters. For a decade they have derided 2001 and 2003 tax laws as “tax cuts for the rich.” If that were true, they should let them sunset without a peep. They won’t.

Similarly, they will argue that the 2009 tax cuts are necessary for economic growth, despite the fact that the bulk of these credits are government spending in disguise that has done little to bolster economic prospects.

With the posturing out of the way, the commission could turn the clock to 2000 and make progress on a 21st century tax code that is pro-growth and supports the upward mobility of American families. Certainly such a code would include familiar elements. It would keep marginal tax rates low and feature deductible IRAs and other vehicles that support saving, investment, and capital accumulation. The combined sunsets would put nearly $300 billion on the table for these purposes and bi-partisan blessing could locked them into place and provide a stronger signal to the private sector.

But it would avoid other features that have become too common, noticeably the extensive use of refundable tax credits. As noted earlier, these are really spending programs implemented via the tax code. But they have an even more damaging feature. Because a “tax” occurs whenever one earns $1 but doesn’t end up with a full $1, the phase-outs of tax credits are hidden taxes. You used to have something, but because you worked and earned more, the government took something away—just another tax.

These hidden taxes undercut the upward mobility of American families. Especially if the Senate health care bill passes, the effective marginal tax rates on lower and middle-income singles and families will be higher than the top marginal rates—as high as 41 percent of each additional dollar. The tax code should not impede so strongly the progress of poorer Americans.

Finally, the commission would have to take on some of the base broadening absent in previous efforts. There is no compelling case for an open-ended tax subsidy to leverage in mortgage finance or employer-sponsored health insurance. These are two of the largest, most pernicious, and durable examples of anti-growth subsidies to consumption over saving embedded in the tax code.

The road to tax reform includes the recognition of the importance of low marginal tax rates, the need to support the upward mobility of Americans, and the danger of inefficient tax-subsidies to favored forms of consumption. But it also includes ending some of the myths regarding the fairness and effectiveness of past efforts. The commission will be uniquely positioned to accomplish this mission.

Douglas Holtz-Eakin is president of the American Action Forum, a center-right policy institute in Washington, D.C. He has a distinguished record as an academic, policy adviser, and strategist. He is also a commissioner on the Congressionally chartered Financial Crisis Inquiry Commission.