Friday, October 21, 2011

Bill Bradley on Tax Reform

This year marks the 25th anniversary of the Tax Reform Act of 1986. Whether you liked it, hated it, or come down in the middle, TRA 1986 was a monumental event in the history of U.S. tax policy.

To commemorate the anniversary, the editors of Tax Notes profiled several veterans of the 1986 tax reform effort this week. Nearly all of the interviews and personal recollections are worth a quick read. However, I wanted to spend a few minutes summarizing Meg Shreve's interview with Bill Bradley.

Bill Bradley is a former Senator (D-NJ) and Democratic presidential candidate. His popularity traces back to his career as a hall of fame basketball player with the New York Knicks. He was no intellectual slouch, attending Oxford as a Rhodes Scholar after a basketball career at Princeton.

Highlights from the interview:

[1] We need to define "tax reform."

Bradley emphasized that we can't do tax reform without defining tax reform. Do we close loopholes and use all the revenue from to lower rates? Or do we close loopholes and use only some of the revenue to lower rates (with some of the revenue dedicated to deficit reduction or new programs)? Alternatively, do we shift the paradigm by lowering income tax rates and offsetting the revenue shortfall with a consumption tax or some other source of revenue (e.g., a carbon tax)?

In 1986, political leaders defined tax reform as revenue-neutral loophole closers. Republicans wanted lower rates, and Democrats wanted fewer loopholes. In a sense, the stars were aligned to permit a political consensus. The Code was riddled with loopholes that were exploited by the highest earners, and top marginal tax rates were high. By eliminating loopholes, TRA 1986 increased taxes on the individuals and businesses that exploited the loopholes. The increased tax revenue was used to "pay for" lower tax rates across the board. The result was that "the top 5 percent paid a higher percent of the income tax revenue after tax reform than before tax reform even though the rate dropped from 50 to 28 percent."

Unfortunately, defining tax reform is more difficult today. Today's "loopholes" are tax expenditures that benefit tens of millions of middle-class taxpayers. Top marginal tax rates are lower today than in 1985. Even without the rancorous climate in Washington, it would be heavy lift for political leaders to adopt the 1986 definition of tax reform.

[2] We need a president that is "full square" behind tax reform and a Treasury Secretary with the gravitas to cut a deal.

Bradley recounted President Reagan's commitment to tax reform. Reagan "gave a couple of speeches," but delegated broad authority to former Treasury Secretary James Baker to cut a deal. Reagan "made it acceptable and led the charge." Baker ultimately brokered a tax reform deal with Bradley himself.

If Bradley is correct, we aren't going to see tax reform before 2013 or 2017. Meaningful tax reform is not a priority for President Obama. His priorities range from socialized health care and "spreading the wealth around" to green jobs and hybrid vehicles that will run 120 miles on a gallon of fuel. His Treasury Secretary, Timothy Geithner, is a bookish technocrat who has struggled to tread water due to economic conditions outside his control.

Bradley did not put a grade on Obama's efforts to drive tax reform. He suggests that Obama has been evasive for political reasons ("If the answer is 'we need to close loopholes to raise revenue and we don't touch rates' -- if that's what you mean, then say it.").

[3] Tax reform is too complicated for most people and will never be a "mainstream" issue. But political leaders need to articulate the principles guiding reform.

Bradley explains that the 1986 reforms were motivated by three simple principles. First, equal incomes should pay equal taxes. Second, the income tax should be progressive (those with higher incomes should pay more). Third, the market is more efficient at capital allocation than the Ways and Means Committee.

Team Obama has struggled to articulate clear, simple principles in respect to tax policy. Obama wants to increase taxes on "millionaires and billionaires," but defines millionaires as married working professionals with taxable income of $250,000. The income tax is steeply progressive, with the top 1% of taxpayers contributing 37% of income tax revenues. But he wants to "spread the wealth around" further, without defining what constitutes a "fair share." He has caught the "Buffett Bug," and become obsessed with the effective tax rates paid by the 400 top earning individual taxpayers. He sniffs at Bradley's quaint notion that the market is better at capital allocation than legislators and bureaucrats in Washington.

No wonder that individual Americans are confused and frustrated by the rhetoric around tax reform.

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