Commentary

Will Tax Reform Be an Increase?

This article appeared in the Washington Times on August 8, 2005.

Will President Bush reverse course on fiscal policy and raise taxes? At first thought that seems unlikely because the president would not want to tarnish his tax-cutting record. But “tax reform” has replaced “tax cuts” on the Washington agenda, and that poses dangers for taxpayers.

The president’s tax reform panel, headed by former Sen. Connie Mack, will report its findings in September. The panel is charged with proposing “revenue-neutral” options, which seems to rule out tax increases. However, in at least three ways higher taxes threaten to become part of tax reform.

The first threat is the alternative minimum tax. The revenues from this add-on tax are expected to explode from $20 billion in 2005 to $112 billion by 2010. The administration says it wants to fix the AMT on a revenue-neutral basis — but that means surrendering to a tax increase of about $750 billion over the next decade. The president’s tax panel has similarly included rising AMT revenues in its baseline, thereby baking a tax increase into the tax reform cake.

Tax increases are bad economics, and this approach is also bad politics. Consider a tax package that combined repeal of the AMT with repeal of some tax breaks, such as the deduction for state taxes. Taxpayers would see the former as an intangible future benefit, but the latter would hit them very directly.

A better idea is to repeal the AMT outside of tax reform and offset the budget impact with spending cuts. Most policymakers, including liberals from high-tax states, say they favor AMT reform, so let’s get that done first. Then, a tax reform package could combine tax rate cuts with ending the state tax deduction and other breaks. That would be a fair swap taxpayers would understand.

A second tax threat stems from the president’s panel using static revenue scoring for tax proposals. This is not an obscure accounting issue. Static scoring will result in a reform raising too much money if enacted because the growth benefits will not be considered as they would be with dynamic scoring.

Use of static scoring also means panel proposals will be less politically viable. Consider corporate tax changes. A reform package could include a tax rate cut in exchange for eliminating some inefficient tax breaks. A static analysis might show ending such breaks would raise enough money to reduce the corporate rate 5 percentage points.

However, we know a corporate rate cut would lose only about half the revenue a static score would indicate because of the long-run positive growth effects. Thus a dynamic score would show ending these particular tax breaks would allow a 10 percentage point cut in the corporate rate. That larger rate cut would generate stronger business support for reform.

A third tax threat is that a revenue increase might creep into a reform package as it moves through Congress. Legislators might see tax reform as a chance to create a new value-added tax to pay for rising entitlement costs. Unfortunately, President Bush has a record of sending reform-oriented bills to Congress that get morphed into big government bills and then signing them into law anyway to score legislative victories. The 2002 education bill and 2003 prescription drug bill are wonderfully depressing examples.

Might there be a similar disaster with tax reform? Would the president sign a “reform” bill that made his prior tax cuts permanent, sprinkled in breaks for his favored causes such as education and imposed a VAT to win the votes of deficit hawks? I fear such a “bipartisan compromise” would create a more powerful tax engine that fuels higher government growth.

The president should be lauded for putting tax reform on the agenda and assembling a distinguished reform panel. But conservative policymakers need to closely watch the process. They should reject tax increases related to AMT repeal. They should ensure Congress dynamically scores the options proposed by the president’s panel. And they should derail tax reform if it becomes a vehicle to close the budget gap rather than create a higher-growth economy.

Chris Edwards is director of tax policy at the Cato Institute.