T. R. Reid has had a long career
as a journalist and author. One of his
best products was a volume titled The Healing of America: A Global Quest for Better, Cheaper, and Fairer Health Care. This book was published around the time that
the program now known as Obamacare was being assembled and passed into
law. It provided an excellent comparison
between healthcare systems in other countries and that operating in the United
States. Reid’s message was that we in
the US can do a lot better if we would only be willing to learn from
others. He has recently produced another
timely book focused this time on the topic of taxation: A Fine Mess: A Global Quest for a Simpler, Fairer, and More Efficient Tax System. Reid again produces a short, clear, highly
readable comparison between the US and other approaches to taxation in use
around the world. Again, the message is
that we could learn a lot from others.
Reid states that while the
initial passage of the federal income tax occurred in 1913, it was not until 1922
that the law settled into a well-established form. Over the course of time conditions change and
lawmakers feel compelled to “tweak” the tax system and it becomes more
complicated and more unwieldy. By the
time of Eisenhower’s administration it was clear that the legislation needed a
major rewrite in order to render it more efficient. That new version was generated in 1954. As before, this version was subjected to
continual modifications as legislators felt a need to accommodate various
special interests. It would be in the
1980s that a sprawling and confusing tax code generated enough disgust to
render another rewrite necessary. This
would take place under Ronald Reagan in 1986.
Reid takes note of the fact that major rewrites have occurred every 32
years, making the timing for the next rewrite to be 2018. How much more timely could an author be?
The path to tax reform in 1986
was not simple, but after several years of arguing back and forth between
political partisans, a very simple approach began to be viewed in a positive
light by both sides and strong bipartisan support for the new tax code was
attained. The lessons of that period
should inform the current deliberations on tax modification, but the attempt to
avoid bipartisan support probably means we will not see the needed rewrite on
Reid’s 32-year schedule. Nevertheless,
Reid’s perspective is informative.
Reid makes the dubious claim
that politics in the Reagan era “was as fractious as it is today.” At the time of the relevant taxation
deliberations we had Republicans in control of the presidency and the Senate
while Democrats controlled the House of Representatives. Reid attributes credit for the needed political
momentum to two people.
“These
two were strange bedfellows indeed. One
of them, a conservative Republican, was a Wall Street tycoon; the other, a
liberal Democrat, was a basketball star.”
The Republican was Donald Regan
who accepted the post of secretary of the Treasury under President Reagan. He was not an ideologue and thought our messy
system could be improved by studying what other countries were doing in the
taxation arena. He was particularly
interested in what was taking place in New Zealand, a country that was already
moving in a direction that seemed appropriate for the US as well.
Essentially all nonpartisan tax
experts advise countries to adopt an approach tersely summarized as “broad
base, low rates,” or even more simply: BBLR.
The notion is that high taxes affect economic decisions which lead to
inefficient economic outcomes. It is
better that decisions be based on their intrinsic properties rather than on tax
considerations. The goal then is to
attain the needed funds to run government with the lowest possible rates of
taxation. The way to do this is to
broaden the tax base as much as possible.
Every existing special tax deduction or allowance then has the effect of
narrowing the base and requiring higher rates.
New Zealand possessed a complex mess for a tax code and decided to apply
the BBLR principle in order to fix it.
“It
relied primarily for revenue on a personal income tax, and the tax was riddled
with exemptions, credits, and giveaways for particular groups and
companies. In short, it was the opposite
of BBLR. All those preferences made for
a fairly narrow tax base, which meant that tax rates had to be high to raise
the required revenue. By the early
1980s, the top marginal income tax rate was 66%.”
The tax specialists were tasked
with lowering income tax rates by half.
This they accomplished by eliminating essentially all of the special
provisions that had been inserted into the previous code and by establishing a
national sales tax that has dwelled in the 10-15% range. This tax was labeled a goods and services tax
(GST) but it is equivalent to the value-added taxes (VATs) in place in most
nations of the world.
“With
that addition, the income tax rates could be cut in half for every tax payer in
the nation—with no loss of revenue to the government.”
Reid estimates that a couple in
the US with the median income will average paying about 35% of earnings in
income taxes and healthcare insurance. That
includes federal, state, local, and payroll taxes (Social Security and Medicare).
“In New
Zealand, in contrast, the median wage earner pays about 17.5% in income
tax. But that one payment also covers
his old-age pension (there’s no separate tax for Social Security), plus free
healthcare for life (there’s no separate tax for healthcare), plus free
education through college graduation (there’s no separate tax for
schools). So the average New Zealander’s
wages are taxed at less than half the rate of the average American’s. And yet New Zealand provides more government
services than the United States—with half the tax rate. That’s the beauty of BBLR.”
One must remember that New
Zealand’s consumption tax (value-added tax) is also much more efficient at
collecting funds than the array of state and local sales taxes that are so easy
to cheat on, and we waste much more money than anyone else on healthcare. But yes, there are things to be learned from
other countries.
The driver for tax reform from
the liberal side was Bill Bradley, a basketball all-American at Princeton and a
Rhodes Scholar who followed that up with a career as a star player for the New
York Knicks of the NBA. Bradley’s
interest in federal taxes is said to have arisen when he learned that as a
player he was considered a “depreciable asset” by his employers. He entered the Senate representing New Jersey
in 1978 and began focusing on the issue of taxation. His goal was to apply the principles of BBLR
in order to be able to lower tax rates.
“’The
trade-off between loophole elimination and a lower top rate became obvious,’
Bradley wrote later; ‘the lower the rate, the more loopholes had to be closed
to pay for it.’ Bradley stuck to the
mantra of ‘broad base, low rates’ for years, telling anybody who would listen
that a significant cut in tax rates would win the votes needed to broaden the
base. ‘The key to reform was to focus on
the attractiveness of low rates, not on the pain of limiting deductions.”
When Regan, his successor at
Treasury, James Baker, and Bradley brought a credible proposal to President
Reagan in 1984 to significantly cut tax rates he bought into the idea. Legislation would eventually pass in 1986
after much political haggling.
The tax legislation passed in
1986 is startling in the changes that were approved. The fact that it could actually be passed by
a bipartisan vote is astonishing given today’s environment.
“The
1986 law, generally recognized as ‘the most significant reform in the history
of the income tax,’ reduced the top marginal rate for individual taxpayers from
50% to 28%—the biggest reduction of any tax bill before or since. It did that by eliminating a broad range of ‘tax
shelter’ breaks available only to the rich.
It cut back the deduction for mortgage interest and completely
eliminated the deduction for interest on consumer loans, like auto loans and
credit cards. It eliminated the
deduction for state and local sales taxes.
It limited deductions for charitable contributions, IRA deposits,
medical bills, and other personal expenses.
It set the tax rate on capital gains—that is profit on stocks, real
estate deals, and so on—at the same level as the top income tax rate, so that
financiers could no longer cut their tax bill by defining all their pay as
capital gains.”
“The
new law produced significant tax cuts for low-income and median-income
Americans and provided tax savings for the rich as well. But somebody had to pay for all that lost
revenue, and the burden was shifted largely to corporations. Although the bill cut the basic corporate tax
rate, from 48% to 34%, it took away so many of industry’s cherished credits,
deductions, and depletion allowances that corporate taxes increased by some
$120 billion over five years.”
It may be difficult to believe
now, but at one time the United States was the shining example of how to
produce tax policy.
“This
stunning and unexpected tax reform, particularly coming out of a politically
polarized Washington, D.C., drew attention, and prompted action, around the
world. When little New Zealand
transformed its tax code, the other wealthy nations found it interesting; when
the mighty United States did the same thing, the rest of the world found it
imperative, on political and fiscal grounds, to do the same. In short order, Britain, Ireland, Canada, the
Netherlands, and other democracies dramatically lowered their tax rates by
broadening the tax base. The OECD called
this wave of tax reduction a ‘global revolution,’ and the United States lit the
spark.”
But politicians do what
politicians do and “money doesn’t talk, it swears,” so over the years, even New
Zealand’s tax code became cluttered with exceptions and had to be rewritten in
2010. Our politicians have also been
busy. Corporate taxes produce ever less
in relative revenue and the demand is to cut that revenue even further. Mechanisms for tax avoidance inexorably grow
causing the government to either raise rates or borrow money to keep the ship
of state afloat.
“After
proudly patting itself on the back because of the 1986 reform, Congress in the
next three decades made more than thirty thousand changes to the 1986
code. Most of them ran counter to the
ethos of BBLR. Virtually all of them
made the tax code more complicated—including that bizarre ‘anti-complexity
clause,’ Section 7803(c)(2)(B)(ii)(IX).”
It is hard to believe that only
three decades ago Congress was capable of acting on such a major bill. Reid may see his 32-year prophecy come to
pass, but it is unlikely that the result will be viewed as a worthwhile
accomplishment by the American people—let alone by the rest of the world.
The interested reader might find
the following articles informative:
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