Crusade To Fix Tax Code Gains Steam

Originally published on July 9, 2011 6:30 pm

After leaving negotiations on raising the debt ceiling this week, House Speaker John Boehner said, "Comprehensive tax reform ... is under discussion."

Next week, the House and Senate tax-writing committees will hold a joint session on tax reform for the first time since 1940.

The idea of tax reform has been tossed around Washington left and right the last few weeks. Most Democrats and Republicans agree that the tax code is unfair and overly complex. But what exactly is wrong with it? What are lawmakers planning to do it about? And could a bipartisan deal actually solve the fiscal crisis?

A Case Study: Capital Gains

While the income tax rate on America's highest earners is 35 percent, many of those earners actually pay quite a bit less. That's because much of their income does not come from traditional wages, but from stocks and bonds — money known as capital gains, which is taxed at 15 percent.

"It's an obsolete provision that originated in the 1970s when we had double-digit inflation," David Stockman tells weekends on All Things Considered host Guy Raz. Stockman, the budget director under Ronald Reagan, supported the capital-gains measure at the time as a congressman from Michigan. "With double-digit inflation," he says, "you were taxing phantom gains."

The U.S. hasn't suffered from that kind of inflation in 30 years. Since then, the low capital gains tax has become a huge windfall for the rich.

"Worse, it is an incentive to get all of the high-paid tax lawyers and accountants in the world to figure out ways to transform earned income into capital gains," Stockman says.

If capital gains were taxed at the same rate as regular income, he says, the government could bring in tens of billions of dollars more each year. But more importantly, he says, ending the perverse incentives could lead to even more revenue down the road when income of all types is taxed uniformly.

Devilish Deductions

For Democratic Sen. Mark Warner of Virginia, the devil is in the details, namely the many thousands of deductions that have been added to the tax code in the past 25 years.

Warner tells Raz that these tax policies "individually might make some sense, but in aggregate, they make our code much too complex."

Warner argues for a decrease in the top income tax rate — from 35 percent to somewhere around 30 percent — paired with reductions in tax write-offs, such as the home mortgage deduction.

"Let's just make it apply for the first home, and instead of having a $1 million cap, have a $500,000 cap," he says.

Because changes to these deductions would face strong blowback from special interest groups, Warner advocates tackling the whole tax code at once.

"I think the only way, in a practical sense, you do it, is if you put a package together that has a bit of shared sacrifice and everybody has skin in the game," he says.

"If you do these sequentially, the forces of the status quo will always win."

A Problem Of Biblical Proportions?

Republican Rep. Charles Boustany of Louisiana says he, too, is alarmed at the amount of deductions on the books.

"The tax code is 10 times larger than the Bible, without the good news," says Boustany. He sits on the House Ways and Means Committee, which is in charge of overseeing the tax code.

The tangle of write-offs and loopholes makes even the laws of Leviticus seem succinct, he says.

He tells Raz the tax code is "complex not only for business owners and for families who have to grapple with it, but also complex from an administrative standpoint." Refundable tax credits have been particularly problematic, he says.

"We've seen overpayments, we've seem some fraud, and we've had a number of hearings on this in Congress," he says.

Boustany says Congress must develop a series of metrics to evaluate the economic impact of each tax credit and analyze them one by one.

He foresees tax reform as a drawn-out process. But even in a hyperpartisan Congress, he says, both sides have shown the seriousness necessary to get a deal done.

Rocky Road To Reform

Eugene Steuerle is intimately familiar with the drawn-out process of tax reform. While working at the Treasury Department in 1984, Steuerle became a primary architect of what became the Tax Reform Act of 1986. The act closed many loopholes and was passed with bipartisan support. But Steuerle says it didn't get everything right.

"We didn't do a very good job in '86 at restricting the new special provisions that would come on immediately after," he says. "We didn't get very far with dealing with those provisions that are very large and expensive, but apply mainly to the middle class."

Steuerle thinks U.S. fiscal problems are too deep to be solved by taxes only on wealthier Americans, even though he acknowledges that that group has disproportionately benefitted from the current tax code.

"Most government is supported by the middle class and most of the benefits of government go to the middle class," he says.

Yet tax increases on the middle class in this climate would be politically tenuous, if not suicidal.

"We have had a government that for at least 15 years now and maybe longer, that has never really asked the public for much of anything," he says.

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GUY RAZ, host: Believe it or not, there's one topic that virtually every lawmaker here in Washington agrees about. And that is America's tax code is a mess.


Representative CHARLES BOUSTANY: I've heard it said that it's 10 times the size of the Bible without the good news.

RAZ: That's Republican Congressman Charles Boustany from Louisiana. We'll hear more from him in a moment. He's in the House Ways and Means Committee. And this coming week, that committee will hold a historic joint hearing with its Senate counterpart about changing the way we all paid taxes.

And reforming the code is something President Obama is even discussing with House Republicans. Question is: How do you untangle the Web that already exists? That's our cover story today.



RAZ: Now, last year, the U.S. government spent $3.5 trillion. But because of high unemployment and a weak economy, it only collected just over two trillion in taxes. And unless something changes pretty soon, the government faces chronic shortfalls for the foreseeable future, which is why so many members of Congress want to change the tax code, including Republican Dave Camp. He's the chairman of the House Ways and Means Committee.

Representative DAVE CAMP: We need to make sure we have a constant effective rates. So what we're looking at is doing away with some of these exceptions, loopholes, business provisions, whatever you want to call them that make effective rate different for different companies.

RAZ: Now you've probably heard that America has the highest corporate tax rate in the industrialized world. At 35 percent, that is actually true. But what that number doesn't reveal is that very few corporations in America pay anything near that rate because of all of the hundreds and thousands of loopholes and incentives and credits in the tax code.

The difficulty in fixing the problem will be coming to a compromise over which incentives to ditch and which ones to keep. Here's Virginia Senator Mark Warner. He's a Democrat and a leading voice on tax reform.

Senator MARK WARNER: The tax code right now is 70,000 pages long. It literally costs hundreds of billions of dollars in terms of transaction cost for individuals and companies to fill out their taxes. Many of the exemptions, tax policies we've made over the last 25 years, individually, they might make some sense, but in aggregate, they make our code much too complex.

So our goal is to actually lower tax rates, but at the same time, remove a lot of these tax exemptions, recognize them for what they are, which is government spending by a different name.

RAZ: Now the tax rate right now is 35 percent. Under your proposal for an individual or for a couple or joint filers, what would the top rate be?

WARNER: Well, we're still talking about that. It would go down. The question is whether it's 30, 32, 29. I mean, I think those are issues we still got to work through, but it would go down. But at the same time, I would then be giving up some of the tax exemptions that are currently in the code.

RAZ: When you say exemptions, what are you talking about specifically? Home mortgage interest deduction, for example?

WARNER: Well, no one's talking about elimination of - a home mortgage deduction elimination. The Simpson-Bowles commission said, let's just make it apply for the first home. And instead of having a million dollar cap, have a $500,000 cap.

It might be that you would get your first $100,000 of charitable contributions fully written off. But after that, you'd only get a 50 percent write-off. It would mean a whole series of issues around other tax preferences. And there are literally thousands of them in the tax code that we would, if not eliminate some, at least cut them back a little bit.

You know, at the end of the day, I think most reasonable people agree we've got to cut spending. It's at an all-time high. Revenues are at a 60-year low. You can either do that by raising rates or you can do that by actually lowering rates but getting rid of tax expenditures. I think the way that is long-term cleaner and long-term probably more efficient is looking at lowering rates and then getting rid of some of these tax expenditures.

RAZ: Let's talk about outside influence here. Because as you know, when it comes time to picking which incentives and which deductions to eliminate, you're going to have a lot of pressure. You're going to have the real estate industry. You're going to have corporations. You're going to have farming industry and so on and so forth. So how do you pick which ones are legitimate and which ones aren't?

WARNER: I think that's, in effect, what we're hired to do. And if we don't do a good job, we ought to all be fired. But I also think the only way, in a practical sense, you do it is if you put a package together that has a bit of shared sacrifice and everybody has to get in the game.

If you do these sequentially, the forces of the status quo will always win. If we do something that says, no, let's try to share this pain around all the different sectors, let's try to make sure that, again, it's balanced with spending cuts as well, so it's not just on the revenue side. At some point, there is that appeal to patriotism over party that the American people, and candidly, I hope and pray, at least the American business will respond to as well.

See, I think this issue is every bit as serious as the threat of fascism, the threat of communism, the threat of terrorism. It really is a question about what America and who America is going to be in the 21st century.

RAZ: That's Senator Mark Warner of Virginia. He joined me from the Capitol building here in Washington. Senator Warner, thank you so much.

WARNER: Guy, thank you.

RAZ: Now back in 1986, the government did reform the tax code. It was simplified. Eugene Steuerle helped write it, and he worked in the Treasury Department at the time. And he says ever since then, members of Congress have essentially undone most of that reform.

EUGENE STEUERLE: So every new elected official thinks that he has to - or she has to tinker with the tax code as well. And so provisions get added on to provisions and we get more and more complexity.

RAZ: And so like barnacles on an old boat, the code grew and grew as members of Congress added their pet tax credits and loopholes to the code. So can it be simplified once again? That's a question I put to Republican Congressman Charles Boustany of Louisiana.

BOUSTANY: Clearly, we've seen an explosion in a number of deductions and credits. And I think what we need to do is have an honest look at all of these and develop some metrics on how you evaluate these credits. Meaning, who benefits, what is the economic impact, do these help create jobs, or do they have a very narrow application.

RAZ: This coming week, the House and Senate Ways and Means Committees will hold a joint - a historic joint meeting. The first time, I guess, since 1940 to discuss tax reform. Let's say the ball starts rolling now and all the members are serious about doing this. How long do you think it'll take to actually accomplish?

BOUSTANY: Well, it's difficult to say. But we know the 1986 tax reform process took a concerted effort of three years and there was work done even prior to that. So we expect this to be a drawn-out process if we're going to get it right. You have to have many, many hearings to investigate all of these aspects of the tax code.

RAZ: Congressman Boustany, as you know, in the minds of many Americans, we are living in an extremely hyper-partisan age. They look at Washington and they see that not a whole lot's getting done. And I wonder if there's an argument to be made that maybe this process should be taken out of the hands of Congress.

In other words, similar to the plan to close down military bases in the 1990s, perhaps there should be an outside committee that simply reforms the tax code that is not necessarily beholden or influenced by outside interests.

BOUSTANY: I disagree with that. And I think, clearly, the Constitution spells out the authority for Congress with regard to the generation of revenues and taxation. In Congress, we are very serious about doing this. We've had a number of closed-door bipartisan sessions of the House Ways and Means Committee with the Joint Committee on Taxation to really look at details and technical aspects of the code.

In fact, the very first week that the committee assembled, we had a closed-door meeting with all the members of both parties. And Chairman Camp, who chairs the House Ways and Means Committee, Dave Camp from Michigan, he outlined his main goal was to undertake tax reform in a fundamental way, and he wants to do it in a bipartisan way as well.

RAZ: That's Republican Congressman Charles Boustany of Louisiana. He's a member of the House Ways and Means Committee. He joined me here in our studio in Washington. Congressman, thank you.

BOUSTANY: Guy, it's really good to be with you.

RAZ: David Stockman was Ronald Reagan's budget director back in the early 1980s. And he says the heart of the tax code problem can be illustrated through one simple example: the rate of taxes on capital gains.

DAVID STOCKMAN: I think the real issue in the top rate is that nobody pays it. In other words, that's the statutory rate. And you can have a great debate whether it should be 35 or 39 percent. I think we ought to let the Bush tax cuts expire, so the top rate would be 39 percent. I don't think that's the real heart of the problem.

The heart of the problem is that we have a preferential 15 percent capital gains rate. And that means that millionaires and billionaires are paying a lower rate on most of their income, which is capital gains and not earned, than the gardeners and the housekeepers who work for them. And that is totally wrong. It's unfair, and yet it's the heart of the tax system problem we have today.

Now why do we have 15 percent capital gains rate? Well, it's an obsolete provision that originated in the 1970s when we had double-digit inflation. And I supported it then as a member of Congress, because with double-digit inflation, you were taxing phantom gains, you know, on capital gains. So a lot of the gain wasn't real. It was simply 10 percent inflation.

But that's all gone. We don't have any serious inflation anymore. And so the whole rationale for a lower, dramatically lower capital gains rate has disappeared. And now it's just a huge windfall subsidy to the rich.

RAZ: Essentially, most of the people who are earning capital gains and socking it away are wealthier, not necessarily wage earners. If you reform that and you taxed it at, say, 35 percent, how much do you think it could actually generate for the government?

STOCKMAN: It would all depend year to year on the rate at which capital gains would be realized. So it wouldn't be as predictable as income tax revenue, which other than, you know, marginal changes in employment wouldn't change that much year to year.

On the other hand, I will say that it would be multiple tens of billions of dollars because there is a huge amount of capital gains in the economy. And the more important point is that it would eliminate the incentive to game the system, to try to turn ordinary, you know, earned income that every other American generates and has to pay tax on into capital gains.

So I think if you ask the tax technicians, you know, they might tell you that you would get 50 or 100 billion a year. But over time, after removing the incentives and putting the tax lawyers toward doing something more useful, I think it would generate even more revenue as income became more evenly and uniformly taxed.

RAZ: That's David Stockman. He is the former budget director for President Ronald Reagan and a former Republican congressman. David Stockman, thank you.

STOCKMAN: Thank you. Transcript provided by NPR, Copyright NPR.