Taxes

Source: Wall Street Journal

Today's (June 18) Wall Street Journal has two noteworthy pieces on tax reform, "Rubio's tax mistake" in the Review and Outlook and Rand Paul's "Blow Up the Tax Code and Start Over" Perhaps now that pretty much everyone agrees the tax code is a mess, something will be done about it.

Paul is sure to be pilloried about the 14.5% rate and whether it will generate enough growth to sustain tax revenues and pay for 20% of GDP spending.

But the structure of the tax code is far more important than the rate. It is refreshing to hear a serious presidential candidate stand up to say

"...repeal the entire IRS tax code—more than 70,000 pages—and replace it with a low, broad-based tax of [rate deliberately deleted] on individuals and businesses. I would eliminate nearly every special-interest loophole. The plan also eliminates the payroll tax on workers and several federal taxes outright, including gift and estate taxes, telephone taxes, and all duties and tariffs. 

It's not exactly the structure I would advocate, but close enough. And close enough even if 14.5% becomes 20%. Or adds higher brackets at higher incomes.  We should talk about the structure separately from the rates to avoid all these distractions.

More deeply it's refreshing to hear a serious candidate start from the premise that the first purpose of the tax code is to raise revenue for the government, in a way that hurts growth as little as possible. As opposed to first and foremost subsidize various activities, people, or businesses.

I also appreciate

every year the Internal Revenue Code grows absurdly more incomprehensible, as if it were designed as a jobs program for accountants, IRS agents and tax attorneys.

As if? We know who it was designed by!

Polls show that “fairness” is a top goal for Americans in our tax system. I envision a traditionally All-American solution: Everyone plays by the same rules. This means no one of privilege, wealth or with an arsenal of lobbyists can game the system to pay a lower rate than working Americans. 

We don't need polls to know this. Our tax system is still based on voluntary compliance.  An increasing sense that there are special rules for special well-connected people can send us to Greek levels of compliance if we're not careful.  And high statutory rates have always led inexorably to complex ways for rich and well-connected to get out, a sad lesson that our friends advocating for 70 or 90% statutory rates seem to wish away.

But I don't think Paul goes far enough.

All deductions except for a mortgage and charities would be eliminated.

Et tu, Rand? If we're going to "blow up the tax code and start over," then why would we put in deductions for mortgage interest and charities?

OK, mortgages taken out under the current tax law should get to keep the interest deductibility. We don't change rules in the middle of the game. But why should new mortgages get an interest deduction?

Any deductions are strongly regressive -- If you're paying a 40% marginal rate, you get your interest payments effectively cut by 40%. If you pay a 10% rate, you get a 10% subsidy.  And after a huge financial crisis, what in the world is the US government doing subsidizing debt anyway?

The right answer is to get all subsidizing out of the tax code. If the government wants to subsidize rich people's mortgages, fine, let it pass a spending bill, and send people checks, on budget. It is exactly the same as a matter of economics. If that subsidy would be an unseemly political act that must be hidden as a deduction, then perhaps it is not wise policy.

Similarly, two words should be enough to consider the "charitable" deduction: Clinton Foundation. I'm not complaining here that this institution exists. But why should it be subsidized by the tax code, and why should that subsidy be given preferentially to rich people? Two more words: "Lois Lerner." Recall, she got her power by being in charge of handing out non-profit status.

(Yes, I work for a non-profit university, whose mission I believe is a public good and worthy of philanthropic support. But if we get rid of all special treatment, institutions doing good work, transparently and not funneling money to friends and relatives, should come out ahead.)

Why open the negotiations with a breach in the wall? The best way to negotiate a broaden the base, lower the rate negotiation is with the firm principle that nobody gets special treatment. There is no better way to get a big base of voters on board than, "look, you're going to lose your mortgage interest deduction. That's the price for wiping out the rest of this mess, and in return I'm going to lower your tax rate so much you're going to come out far ahead. Now, lend me your support to make sure we keep all the other deductions and loopholes out." It is commonly claimed that shared sacrifice builds support for a war. A war this will be.

Totally nuts? When Dick Thaler and I agree wholeheartedly on something, perhaps it has some merit.