Towards a Fairer, Simpler Tax System

If you pay any attention to the world of tax policy, you'll a hear pretty consistent refrain from a number of folks on both the left and the right: Broaden the base, lower the rates. In other words, tax more people in a more consistent manner, but keep the rates at which you tax low. It's not a new idea either. As Jason Fichtner and Jacob Feldmen point out in a working paper for the Mercatus Center at George Mason University, Congress passed a law in 1986—TRA86—intended to do just that. 

That law reduced the effective corporate tax rate and ditched a lot of the existing code's preferential treatment. The idea was to create a (somewhat) simpler and fairer tax system. Yet as Fichtner and Feldmen write, "looking at the 2011 tax code, taxpayers would be hard pressed to find the aspects of efficiency, equity, and simplicity that were improved with passage of TRA86." The problem, they suggest, was that TRA86 left a lot of big carve outs in place, including the mortgage interest tax deduction. The paper quotes an analysis by the Tax Foundation:

First, while the legislation did close special tax shelters for select individuals—events that often became nightly news stories—the reform did little to close the many significant exemptions that inhibit overall economic growth. Also, much of what passed in 1986 to limit special tax loopholes has already crept back into the system courtesy of politicians quick to give in to whatever lobby fills their pockets.

Meanwhile, the authors note, lots of new loopholes crept into the system to replace the old ones:

One unexpected phenomenon is that most tax expenditures that were eliminated by TRA86 have not returned, but new ones have appeared. The rapid expansion of new itemized deductions suggests that the political system gravitates toward special interests and is innovative at doing so….Despite  TRA86's  overwhelming bipartisan support to broaden the base and lower tax rates, tax expenditures returned quickly and in even greater numbers than before TRA86.

Those end result of all those loophopes is much higher rates: Feldman and Fichter cite former Assistant Treasury Secretary John Chapoton's esimate that without so-called tax expenditures, American could reduce tax rates by 34 percent across the board. 

Most everyone likes lower rates. So why haven't the reforms stuck? In the end, the basic story turns out to be pretty simple: Any tax system that appears to be somewhat malleable turns out to be a good target for lobbyists and other seeking special tax treatment. Industries and special interest groups make the bet that it's worth spending money to get special treatment, and once they've gotten what they wanted, they continue to expend money to keep that treatment. Meanwhile, other special interest groups see that their peers are successfully gaming the system and begin pushing for their own special deals and carve outs, and their arguments are bolstered by the fact that other groups are already getting preferential treatment. It doesn't take long before the entire system breaks down and we end up with a tax code that, sadly, looks like the incomprehensible maze we're stuck with today. Complexity breeds more complexity, which is why partial reforms that leave some popular deductions in place frequently don't stick. The trick, then, is not to simply minimize exemptions and carve outs but to work to get rid of them entirely.

Read Jacob Sullum on tax code complexity.