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Sat July 9, 2011
Your Money

Crusade To Fix Tax Code Gains Steam

After leaving negotiations on raising the debt ceiling last Thursday, House Speaker John Boehner said that "comprehensive tax reform ... is under discussion."

On Wednesday, the Senate Finance Committee and the House Ways and Means Committee 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 this month. 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 would 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. This is because much of their income does not come from traditional wages, but from stocks and bonds, income 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 director of management and budget under Ronald Reagan, supported the 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, and that's not all.

"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 over 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 proposes 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," says Boustany, who sits on the House Ways and Means Committee, the group in charge of overseeing the tax code. "Without the good news."

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 that Congress has to 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.

Copyright 2011 National Public Radio. To see more, visit http://www.npr.org/.