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July 1, 2013

Tradeoffs and Tax Reform

Handicapping the chances of real change to the system
IPI expert referenced: Merrill Matthews | In The News | Media Hit
  Accounting Today

BY ROGER RUSSELL

With the number of congressional hearings on tax reform taking place this year, it seems possible that some part of the reform proposals being aired may eventually become law.

Both the House and the Senate have passed budget resolutions that call for substantial changes in current tax law. The House proposal calls for revenue-neutral tax reform, while the Senate proposal calls on the Finance Committee to draft legislation that would reduce the federal deficit by $975 billion by 2023.

In addition to the House Ways and Means Committee and the Senate Finance Committee, the House Small Business Committee and the Senate Budget Committee have held hearings on tax reform, and numerous working papers and discussion drafts have been released. Actual proposals introduced are the Fair Tax Act of 2013 (H.R. 25 and S.122), the Flat Tax Act (H.R. 1040) and the Simplified, Manageable, and Responsible Tax (SMART) Act (S. 173). And the Tax Code Termination Act (H.R. 352) would effectively repeal the current Tax Code and require Congress to write a new one.

The actual likelihood of tax reform is problematical, according to George Pieler, policy consultant and former tax counsel to the Senate Finance Committee. "It depends on how you define it," he said.

"If it means a wholesale or comprehensive package, it is unlikely in the short run. This is partly because, unlike in the 1980s, you have opposite synergy," Pieler continued. "There's a president in office who is absolutely opposed to cutting rates, so almost anything that will be called reform these days will be a revenue-raiser. You could swap things off within a set of exemptions, but that would be just setting interests against each other."

"The cynical view is that putting tax reform on the agenda is a good campaign fundraising move for both sides going into the 2014 and 2016 elections," Pieler added.

"The theory is that if you indicate that every tax preference is in play, people will want to be on your good side. And there's also the legacy argument for both [House Ways and Means Committee Chairman Dave] Camp and [Senate Finance Committee Chairman Max] Baucus," said Pieler.

NEVER WASTE A SCANDAL

The current Internal Revenue Service scandals throw a kink into predictions about the possibility of reform, observed Merrill Matthews, resident scholar with the Institute for Policy Innovation. "It's hard to tell which way it will go," he said.

"It could create some opportunities that you might not have anticipated before the scandal hit," Matthews noted. "Although the real movement is from the Republican side, it could open doors for the Democrats to want to address the issues. The complexity of the code opens it up. There's the notion that if you make the system simpler and easy to understand, it might be a plus and help during the election if the public has a negative response to the IRS scandals."

As an example of the way momentum could be created, Matthews cited the health care bill passed leading up to the conventions in 1996. "President Clinton wanted health care reform, and the Republicans got the feeling that they needed to do something too. They drafted legislation that was enacted as [the Health Insurance Portability and Accountability Act, in August 1996], so they both could go to their convention saying that they passed important health care reform."

Similarly, Matthews indicated, both Republicans and Democrats will want to say that they passed legislation that addresses the IRS issue. "There is a compelling need for reform," he noted. "The code is so difficult to comply with, and people don't know whether or not they are complying with it. Also, it offers ways to hide behind it for people who are doing things they shouldn't be doing."

Matthews suggested one possibility would be to lower rates significantly but cap the allowable deductions. "It's not entirely clear that this is doable. Rather than having groups fighting for particular deductions and exemptions, simply cap their allowable deductions and let individual taxpayers decide which breaks they want. This might be the most politically feasible way to do it," he said.

In testimony before the Senate Budget Committee, Brookings senior fellow Adam Looney said that tradeoffs would be necessary to enact broad tax reform, noting that it is difficult to lower tax rates through tax reform while devoting revenue to deficit reduction and maintaining progressivity.

"Today's long-term budget outlook means that we're likely to need higher tax revenues in the future," he said. "And rising inequality means that changes in policy will be increasingly scrutinized for how they affect the progressivity of the tax schedule. But a tax reform that devotes revenues to deficit reduction and retains our progressive system would have much more difficulty achieving other goals - such as lowering tax rates."

Looney agreed that reform will be more difficult today than it was in 1986. "In that reform, tax rates were lowered substantially and the lost revenue was restored by cutting tax breaks, deductions, exclusions, and other so-called tax expenditures. That reform enhanced economic efficiency without increasing the deficit," he explained. "In the 27 years since then, however, the economic context has changed, making such a reform harder to achieve."

"It's obvious that we need to improve the tax system, and we should always be thinking about how we can," said Looney. "It's exciting to see that Congress is holding hearings."

NEW CHALLENGES

In his testimony to the Senate Budget Committee, Looney noted, he "attacked some of the high-level challenges that policymakers face today in their thinking about tax reform."

"There are tradeoffs," he said. "If you ask whether or not there is likely to be tax reform, I would say that there doesn't seem to be a lot of capacity within Congress to compromise now, and tax reform is all about making compromises. The tradeoffs that are important today are related to the most important and economically divisive issues - how to reign in the budget, how to address income inequality, and also to promote growth in American competitiveness."

Tax reform for businesses must include small businesses and not be limited to simply lowering the corporate tax rate, according to Pat Tiberi, chairman of the House Ways and Means Subcommittee on Select Revenue Measures. At a hearing on the Ways and Means Small Business Tax Reform Discussion Draft, he noted that with the addition of the Obamacare tax of 3.8 percent, small business pass-through entities will have a top federal tax rate of 44.6 percent.

Roger Harris, the first witness to testify at the hearing, agreed. "For many of our clients, the cost of complying with the Tax Code exceeds the taxes they pay each year," he explained.

Harris, who is the president of Padgett Business Services and former chair of the Internal Revenue Service Advisory Council, endorsed making permanent Section 179 expensing and increasing the cash-basis threshold for small businesses to $10 million to ensure that most small businesses are covered by the general cash-basis exception.

"Cash accounting allows a business to operate on the simple principle that money received is income, money paid out is an expense, and what's left is profit," he said. "Many small businesses have a hard time understanding why they must pay taxes on money they don't yet have or why they can't currently deduct money they just paid, resulting in a tax liability on money that is not in their bank account. To make matters worse, the business owner is required to keep more records to calculate this liability."

Harris was optimistic that the stage is being set for progress on tax reform and tax simplification. "There are multiple committees in the House talking about tax reform, and the Senate is starting to take on the issues," he said.

"There is an undercurrent of activity generated by lawmakers on both sides of the aisle, and it gives hope that tax reform has a real chance," he added.


 

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