Deficit Report is Cautious on Tax Reform

The draft report released by President Obama’s commission on reducing on the deficit, much-maligned by progressive icons like Paul Krugman and AFL-CIO President Richard Trumka, takes up some important ideas for reforming the country’s bloated tax code. But what’s most remarkable about the proposal is its considerable caution in approaching tax reform. Though it nudges lots of political sacred cows towards the chopping block, it leaves policymakers considerable leeway to avoid substantial and politically sensitive cuts in tax expenditures.

The meat of the commissioners’ tax reform proposal has three major prongs: wiping out all tax expenditures, including the myriad deductions, credits and other exemptions by which taxpayers can reduce their tax bill, doing away with the AMT and other discriminatory tax provisions, and consolidating income tax brackets into three low rates: 8 percent, 14 percent, and 23 percent. These changes would reverse years of federal tax policy precedent, which has relied on credits to reduce the tax burden of lower-income citizens and deductions to encourage activities like charitable giving and homeownership.

After this reversion to a “clean slate”, the commissioners suggest, tax expenditures could be added back in and paid for by increasing one or all of the new marginal rates. What some commentators, especially those on the left, have missed is that the commission has obviously planned for some popular credits and deductions to remain. Politicians would be given free rein to reinsert provisions like the Earned Income Tax Credit for lower and middle-income taxpayers or the politically ironclad mortgage interest deduction. The report itself even estimates what rates would have to be to preserve some of these programs!

This is not a gutting of the syste,, it’s a pragmatic attempt to “start over” from a clean slate on tax expenditures, hopefully permanently eliminating a good number along the way. Still, it’s difficult to imagine politicians trimming any of the most significant, also the most popular, credits and deductions anytime soon.

Having these previously sacrosanct tax provisions debated in the open is something of a victory in itself. Still, as my colleagues Anthony Randazzo and Sam Staley have noted of the broader proposal, it’s unlikely to create anything more than moderate reform. More significant movement towards a lower-rate, broader-based and simpler tax system may have to wait till the next budget crisis.