Tax reform died this past weekend. I won’t shed any tears, because I never thought it was a good idea. (We don’t need simpler taxes. We need higher taxes.) But with Washington still buzzing about prospects for an overhaul of the tax system, I thought somebody should tell you: It isn’t going to happen. Tax reform was always a long shot, but two recent developments make it impossible.
Obstacle #1: The deal struck last week between Vice President Joe Biden and Senate Minority Leader Mitch McConnell to avert the fiscal cliff. It restored the top marginal rate to the Clinton-era level of 39.6 percent, but only for family income above $450,000. I found this crushingly disappointing, because the fiscal cliff deal was almost certainly the only shot Obama will ever get at raising income-tax rates.
But the $450,000 threshold was also a disappointment to anyone looking forward to tax reform. The central idea of tax reform is to lower rates, make up the difference and then some by eliminating tax loopholes, and use what’s left over to lower the deficit. But so high a floor for the top bracket makes it politically very difficult to lower rates. Families with income above $450,000 fit very comfortably into the much-maligned 1 percent, and voters won’t likely stomach a rate cut for so rarified a group—a group that, in the end, even Republicans were willing to raise taxes on.
Another problem stemming from the fiscal-cliff deal is that an important source of its revenue is the restoration of Clinton-era limits on exemptions and deductions (“PEP and Pease”) for family income above $300,000. This was done to limit the revenue loss attributable to raising the top-bracket threshold from Obama’s proposed $250,000 to the Republicans’ preferred $450,000. The PEP and Pease changes are sufficiently complicated as to be invisible to much of the knuckle-dragging right, as a $250,000 threshold would not. But in taking a bite out of deductions for incomes above $300,000, Biden and McConnell shrank the pool of deductions that could be taken away from this group later. A tax reform-deal would therefore have to rely even more than previously thought on eliminating deductions for families earning less than $300,000, most of whom (i.e., families that earn up to $250,000) Obama has too-generously characterized as the “middle class.”
Obstacle #1 made tax reform very unlikely. Obstacle #2 makes it impossible.
Obstacle #2: McConnell saying (on CBS’s "Face The Nation," Jan. 6) that any tax reform must be “revenue neutral.” As a practical matter, it always seemed unlikely that a swap of lower rates for fewer deductions could reduce the deficit—certainly the 1986 tax reform, which serves as the model, did not. But Republicans have in the past tended to be slippery on the question of whether any tax reform they could support would reduce the deficit. Now McConnell is affirmatively saying it would not. And if (as McConnell asserted on "This Week") “the biggest problem we have at the moment is spending and debt,” then even Republicans have little reason to craft a tax-reform deal that will have no impact on, well, spending and debt. Democrats have none at all.
In a Jan. 5 interview with Wall Street Journal editorialist Stephen Moore, John Boehner insisted that “The president admitted . . . in the first meeting that we needed to do tax reform, and he was for a tax reform process that would lower rates." But if such reform were revenue neutral, I doubt the president would stay interested, even if Obstacle #1 didn’t exist. And anyway, Boehner in the same interview swore off ever negotiating with the president again. That means any future negotiation will fall to McConnell, who seems far less excited about the idea of tax reform than Boehner.
You may still hear Democrats talk about tax reform. But when they do, they’ll probably mean that they’d like to treat capital gains as ordinary income. “Tax reform” will be their euphemism for “higher taxes.” And (while it’s true that the 1986 reform increased capital gains taxes to bring them in line with income taxes) higher taxes aren't what most folks have in mind when the phrase “tax reform” is mentioned.
Tax reform is dead. May its weary bones rest in peace.