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Thursday, February 06, 2003

Taxing Times

Arnold Kling discusses tax reform in the U.S., favourably citing this piece by Alberto Alesina and Francesco Giavazzi, who in turn conclude that:

Piecemeal deregulation is doomed to fail. Generating sufficient political support to enact reforms that can survive the opposition of vested interests requires attempting to deregulate the entire economy simultaneously, not select industries, one by one. The key to eliminating inefficient, unproductive subsidies to minorities is to implement tax reductions for all.

Examples of such "big bang" reform, like the independent base closing commission and the passage of the NAFTA trade agreement are profferred, but something is missing here. The examples depend, to a large extent, upon uncertainty--prior to them being implemented, members of Congress did not have much idea regarding which bases were to be closed, or which tariffs were going to be cut, and on completion of the deal they had a straight up-or-down vote. For measure as important as tax reform, it is in turn difficult to say whether members of Congress, or even the President, would be willing to delegate such power to a "blue-ribbon" panel or a high-powered negotiator. (I am also not sure if Congress can, constitutionally speaking, delegate its tax powers.)

A few months ago in Slate, Robert Shapiro raises economic arguments that work against tax reform, such as discounting the future. In one instance, he talks about "capitalisation" and the resultant losses from any tax change:

For example, the existence of a home-mortgage deduction, the granddaddy of personal tax preferences, has raised housing prices: By reducing the monthly cost of homeownership, the deduction enables home buyers to bid up the price of housing until it roughly offsets the value of the deduction. That's why homeownership rates in Canada, which provides almost no tax benefits to home buyers, are nearly as high as ours. On balance, U.S. home buyers neither gain nor lose. But if tax reform eliminated the mortgage deduction, housing prices would fall, and current homeowners would face windfall losses.

These arguements are part of the reason why, even though there's a tax-cutting Republican in the White House, there's no Kemp Commission-style efforts of overhaul the tax system. While I support broad-based tax reform--I like the idea of a flat tax or a moderately progressive system, along the line of the plan proposed by Jane Galt--part of this "big bang" seems to me to be more wishful thinking than anything else. Kling says that "Piecemeal proposals mobilize the opposition of narrow interest groups. It is easier to neutralize such opposition with 'big bang' approaches." Where is the evidence for this? It took years to get a new fast-track authority passed, and that only after some special interests were bought off with measures like the Farm bill--a huge distortion to world trade of itself. In a New York Times article that Kling quotes, Daniel Altman writes:

Seventeen years after the tax code was overhauled, why has this crippling complexity returned? The reasons are almost entirely political, said Joel B. Slemrod, director of the Office of Tax Policy Research at the University of Michigan. Raising taxes so that more money could be spent had become taboo in Washington, so politicians had to find another way to cater to their constituencies. Tax changes — in the form of credits, subsidies, deductions and refunds — were the answer.

Others take the argument further. "The tax system," said C. Eugene Steuerle, who coordinated the Treasury Department's tax reform group from 1984 to 1986 and is now president of the National Tax Association, "has become the vehicle of choice for influencing economic policy, the distribution of the tax burden, the state of the economy, the social welfare of families, and almost anything else you want to mention."

A radical tax reform, if it takes place, of itself only provides a new baseline for rent-seeking; there is nothing to prevent complication reappearing, as it did following Reagan's 1986 Tax Reform Act. It will far better, IMHO, to convice legislators and voters of the long-run merits of tax simplification, to ensure that any reform is a lasting one.