Time to simplify the U.S. tax code

Mar 2, 2011 Issues: Economy

Clearly there is a need for tax reform. In the 25 years since the last comprehensive review, piecemeal legislation has made a complex tax code still more complex.

In addition, our economy has been dramatically affected by economic globalization over the last 25 years. Competition that was once focused primarily within our borders has become increasingly borderless. Some larger firms that once produced mostly within the United States have become more multinational. This fundamental shift has produced a challenge to the effectiveness of our tax code, with some firms using loopholes and other provisions in the code to reduce their tax liability, resulting in dramatically uneven tax payments.

At the same time, the depth of the last recession has intensified the debate over the proper balance between federal and private action. Governmental action in partnership with the private sector is a powerful and necessary approach to stimulating economic growth and job creation. While there is a new momentum building in our economy, there remains a need to stimulate economic growth, which inevitably has consequences for the tax code. A number of provisions in the tax code have been important instruments of a robust public-private partnership: stimulating research and development, helping to re-energize our industrial base and stimulating new technologies. The Section 48C tax credit, which has successfully accelerated advanced energy manufacturing, is a vivid example of this. The unfortunate exclusion of this important provision from the December tax legislation shows the importance of this debate.

Another dramatic change since 1986 has been the huge increase in the national debt. In 1986 the debt stood at a little over $2 trillion. In the 16 years between 1986 and 2002, it grew by about $4 trillion. Between 2002 and 2008, it again grew by $4 trillion. It now exceeds $13.5 trillion, with the recent increase in part due to the recent deep recession. As a result, I believe that it is essential that tax reform not increase the deficit.

This unprecedented national debt has stimulated debate over major “tax expenditures” to a much greater degree than in 1986. Certain major tax expenditures that were basically retained in 1986, including deductions for mortgage interest, healthcare, charitable contributions and state and local taxes, are now coming under scrutiny. While some tax expenditure provisions are more easily characterized as loopholes because they provide a narrow benefit to a particular interest group, these tax expenditures reflect important socio-economic policies, and therefore require analysis far beyond easy rhetoric or reflexive decision-making.

Finally, that analysis must recognize that, especially in these last years since 1986, there has been a widening gap in Americans’ income. This was reflected in the extension in December of all of the 2001 and 2003 tax cuts. For most middle-income families the extension of this relief occurred in the context of incomes that had been essentially stagnant over the previous decade. In contrast, nearly 80 percent of the benefits of extending the upper-income tax cuts went to the wealthiest one-fifth of 1 percent of taxpayers — those making more than $1 million a year. This occurred even as — in contrast to middle-income taxpayers — the top 1 percent of households were making 30 percent more in 2008 than 2002, and the top one tenth of 1 percent were making 60 percent more.

There needs to be a forthright discussion of these issues as part of tax reform. Indeed, there is only a chance for meaningful tax reform if we place on the table not only old issues that have become more controversial, but also new issues that have become more salient since the 1986 reform.