Sisyphus Had it Easy Reflections on and Budget Reform

By Eugene Steuerle

In the heady days after his re-election, Presi- dent Bush promised to replace the current tax system with something better. Politicians often delude themselves that reform can be sum- moned by proclamation. But, a wholesale trans- formation of the system isn’t about Ito happen quickly or painlessly. In fact, only painstaking bottom-up planning could do the trick. The three major tax reforms since World

18 The Milken Institute Review First Quarter 2005 19 War II – in 1954, 1969 and 1986 – all required highly cherished tax breaks for higher educa- an enormous amount of staff work and tion, not to mention preferential tax rates on Congressional coalition building. And of the income received as capital gains. three, only the 1986 changes amounted to a Meanwhile, the average citizen faces an true makeover. array of tax-based retirement-plan provisions Since the tax system now affects nearly that makes the fabled Clinton health reform every facet of American life, hardly anyone plan look simpler than a Starbucks menu. likely to pay more goes to the shearing with- Check that: I meant Starbucks before the lat- out a bleat. Tax breaks provide indirect subsi- est tax legislation, which grants a tax break to dies to homeowners that are greater than the some integrated coffee chains on “the value of entire budget of the Department of Housing roasted coffee beans used to brew the coffee,” and Urban Development. The Earned Income provided the roasting is done off premises. program is now larger than any Real can’t begin until policy- other welfare program, including food stamps. makers (or, at least, their staffs) understand The break for employer-provided health in- the implications of change for everyone from surance, currently costing $150 billion per caffeine empires like Starbucks to farmers year, is the largest federal health subsidy for who make a living selling their corn to make the non-elderly and is growing faster than al- ethanol additives for gasoline. Saying that one most all other domestic programs. And then, is for tax reform is like saying that one is for of course, there are more than half a dozen eliminating wasteful government expendi- tures; it’s just not very informative. Throwing out the tax code may sound fi ne EUGENE STEUERLE, co-director of the Urban-Brookings Center, served as deputy assistant secretary for in a sound bite. But policymakers still have to tax analysis of the Treasury from 1987 to 1989 and as presi- decide what to do with federal programs for dent of the National Tax Association. Parts of this article are taken from his book, Contemporary United States Tax housing, work, education, retirement, char-

Policy (Urban Institute Press, 2004). ity, energy, environment, transportation and anderson mark

20 The Milken Institute Review The president and Congress have inherited health care and retirement policies that long ago put government spending on an unsustainable track. all the other policies now largely implement- health care and retirement policies that long ed through the tax code. By the same token, ago put government spending on an unsus- someone still has to decide whether the IRS tainable track. The problem is not just that is going to need employees to rate movies spending on the elderly accelerates in 2008, for arousal potential, because Congress has when the boomers start turning 62; it’s also extended the new manufacturing tax break that the growth rate of national income and to that vital piece of the industrial heartland government revenues can be expected to known as Hollywood – excluding, “certain decline along with the drop in the fraction of sexually explicit productions.” adults working and paying . When the Sometimes, reformers can’t ignore the boomers are all in their dotage, close to one implications of tax change, even if they are adult in three will be collecting Social Secu- determined to try. Converting the income rity. The cost of Medicare, another wide open tax to a , for example, would entitlement for seniors, will grow even fast- eliminate special incentives for retirement er than Social Security outlays; the new pre- saving at a time when such saving is one hope scription drug program will only add to the of making it through the baby boomers’ gold- budget problem. en years without bankrupting the Treasury. Exacerbating the fi scal crunch, the last However diffi cult and even quixotic, the few Congresses went on a giveaway spree like quest for tax reform must be undertaken once none other in the nation’s history. New tax in a while if for no other reason than to keep cuts and entitlements, a defense buildup and the arteries of the tax system from becoming more spending for farms, highways, workers, hopelessly clogged with preferences. Trouble doctors, manufacturers and everyone’s favor- is, to keep budget defi cits within bounds, the ite uncle breezed through Capitol Hill. This public would have to swallow the changes as- rapid, unparalleled growth in commitments sociated with base-broadening and simplifi - from a “conservative” Congress has been the cation with an even bitterer swig of defi cit re- major factor wrenching the federal budget duction. Meanwhile, President Bush is at- from short-term surplus to yawning defi cit – tempting to make his previous tax cuts per- a turnaround of 7 percent of GDP. manent, which implies that any defi cit-cut- In the current post-election budget milieu, ting measures he proposes would suck more the powerful push for tax reform that does cash from fewer pockets. The same can be not affect total revenues can mean much more said of changes required if part of the Social than simplifying and rationalizing some of Security tax is redirected into individual ac- the provisions catalogued above. Some want counts, leaving Washington to cover the sys- a revenue-neutral reform to further lower tax tem’s existing liabilities from other sources. rates (particularly on investment income) as The backdrop for reform is even darker. a matter of economic policy, and competing The president and Congress have inherited consumption tax proposals abound. Every

First Quarter 2005 21 A common place of conflict is the nexus between progressivity and individual equity, since taking from A, a person with means, to give to B, a person with needs, typically also denies A some of the rewards of his or her own work.

special break in the tax code has a private that those with equal ability to pay should lobby to defend it, not to mention a cheering pay equal taxes. section within the government bureaucracy. • Progressivity, or “vertical equity,” suggests that those with greater needs should receive retreat from tax principles more from government and that those with Tax breaks – “tax expenditures” in econom- greater ability should pay more to govern- ic jargon – account for one-fourth to one- ment. third of government benefi ts and subsidies. • “Individual equity” holds that individuals The tax code is riddled with preferences that are entitled to the product of their own labor undermine the goal of equal treatment under and to a fair return on their own saving. the law, distort investment and consump- • Effi ciency requires that programs should tion choices, and boost administrative and operate with as little waste or distortion of enforcement costs. behavior as possible. Clearly, simplifi cation is among the most • Simplicity and transparency complement slighted tax principles. of the the fi rst four principles. University of Michigan estimates that the These principles sometimes clash. A com- value of time spent on fi ling income tax mon place of confl ict is the nexus between returns alone is equal to about 10 percent of progressivity and individual equity, since tak- the total income from tax collections. This ing from A, a person with means, to give to B, tax is no argument for stripping every a person with needs, typically also denies A preference from the tax code – some do serve some of the rewards of his or her own work. defensible social purposes. However, there is But such confl icts don’t explain how far we’ve little excuse for the inequity, ineffi ciency and strayed from the righteous path. The tax sys- complexity associated with, say, the alterna- tem is rife with examples in which one princi- tive minimum tax, or the layers upon layers ple is violated without furthering another. of savings subsidies, child credits and allow- ances, rates and energy and retreat from budget principles environmental subsidies. This morass has Improving tax policy requires at least some formed because both major political parties modicum of budget discipline. Unfortunate- have all but abandoned traditional tax reform ly, that’s pretty much disappeared, too. Per- principles. haps the most troublesome transgression is Does anyone even remember what those the way Washington is effectively restricting principles are? Here’s a quick reminder: future budget choices. • Equal justice, or “horizontal equity,” asserts The name of the game in Washington and

22 The Milken Institute Review most state capitals these days is to spend the money before somebody else does. And that means spending not just today’s rev- enues, but tomorrow’s as well. Throughout most of the nation’s his- tory, Congress avoided budget deci- sions that dug an enduring hole. Indeed, except in wartime, eco- nomic growth prompted suffi - cient growth in revenue to cover temporary defi cits created by high- er discretionary spending. Thus, even careless spending, or tax-cutting, did not perpetuate future defi cits. But over the past quarter-century, the dividends of econom- ic growth have come to be fair game. Even if the Bush tax cuts had not been made, retirement and health programs alone would have absorbed all revenue growth in coming decades. Spending ahead in this way has become a glaring economic problem. Nobody knows tomorrow’s needs well enough to be sign- ing such binding contracts today. But you wouldn’t know it if you watched lawmakers at work. For example, advocates of maintaining built-in growth in Social Security benefi ts (through ever-higher annual benefi ts keyed to wages and through more years of retire- ment support as we live longer) contend that we can always change the law later. Elected offi cials pushing tax cuts even further into the future play the same game: they cut back lessons from on future taxes that would help fi nance gov- the 1986 tax reform act ernment, meanwhile spending all the revenue Judging by tax and budget history, Washing- that would normally accompany econom- ton won’t quickly dig us out of this quagmire. ic growth. The bottom line is that such pre- Tax reform might not materialize for a few spending and scheduling of future tax cuts years; changes in Social Security – which is treats future voters as if they were unreliable not nearly as complicated to reform as taxes adolescents who need to be controlled and – may come fi rst. President Reagan called for ensures that government is designed around tax simplifi cation in January 1984 but didn’t

mark anderson mark yesterday’s needs. sign the bill into law until October 1986.

First Quarter 2005 23 tax and budget reform handedness convinced at least some taxpayers Moreover, Reagan was riding the momen- that the reform effort was a sincere attack on tum of two major defi cit-reduction packages unfair preferences – not on particular groups and a Social Security reform that took place or individuals. Many taxpayers were willing during his fi rst term. In short, by 1986 there to pay the price of tax reform because they was room for systemic tax reform on the pol- believed that they were not being singled out icy agenda because Congress had already to pay its cost. engaged in defi cit-cutting and other system- One key to success in reform is assigning ic reform. personal responsibility for failure. After Trea- Still, tax reform meant tough choices. sury Secretary Donald Regan put forward Building a viable majority for reform in 1986 the Treasury’s tax reform study in late 1984, required policymakers to abandon some conservatives and liberals generally agreed changes proposed initially. When estimates that what was proposed was better than what revealed signifi cant revenue losses as a result we had. Those who successively shouldered of these political compromises, new “losers” primary responsibility – Treasury Secretary had to be identifi ed. In short, anyone exercis- James Baker, House Ways and Means Com- ing leadership in this give and take had to mittee Chairman Dan Rostenkowski, and have political backbone. Senate Finance Committee Chairman Rob- I had just returned to the Treasury Depart- ert Packwood – understood that they couldn’t ment from a sabbatical year in 1984 when deviate far from the ground rules set when the role of economic coordinator of the tax reform began. Once it became clear that a sys- reform work fell into my lap. The charge to tem could be designed to lower rates, elimi- study reform came, almost like it does today, nate shelters, remove the poor from the tax with little instruction on what reform was to rolls, help to equalize treatment of individu- entail. Also, like others do now, we fl irted with als with equal income and even to make con- consumption-tax and fl at-tax proposals but servative and liberal support coalesce, none ultimately adopted the more conventional of them wanted to go on record as block- rate-lowering, base-broadening theme. ing reform. As a result, the Tax Reform Act One strategy that paid off was to make a of 1986 managed the largest restructuring of comprehensive study that pooled every possi- incentives and priorities ever achieved in a ble observation on how income was excluded roughly revenue-neutral act. from the tax base (or unnecessarily counted twice) and every conceivable remedy. Com- prognosis for a bush tax reform prehensiveness, of course, meant attacking More than the moon and stars must align to even the small, often overlooked, problems. once again enact signifi cant changes to such This had two advantages. The fi rst comes an all-encompassing system as the federal tax under what I coined the “hopper” theory of code. Sure, the Republicans or Democrats can reform: if more good things went into the avoid coalition-building when giving away hopper, the more good and the fewer bad more money to their favored constituen- things likely would emerge in the legislation cies in the name of reform, but that’s not the if Congress fi nally acted. Second, although game at hand. Inevitably, revenue-neutral this all-points approach took more special reform will increase taxes for some as it low- benefi ts away from more people, its even- ers taxes for others. For true reform, Repub-

24 The Milken Institute Review ments. True, there have been some state- ments about moving toward a consump- tion tax, preserving mortgage interest deduc- tions, taming the alternative minimum tax, and retaining progressivity. But those state- ments merely identify who might win or hold ground, not who is going to pay. And reconfi guring taxes according to basic prin- ciples is much tougher now than it was in the mid-1980s, because the long-term defi cit outlook is much more problematic. Indeed, the broader battle between defi cit reduction and what-me-worry politics has become the gorilla around which the other legislative monkeys must play. Still, just as in the mid-1980s, there would be grave political consequences for doing nothing to reform taxes. This time around, the alternative minimum tax is on track to ensnare 29 million households in an expanded paperwork nightmare by 2010. Most of these will be families with children, since the alternative minimum tax treats the dependent exemption like a tax shelter. This time around, the Meanwhile, real tax shelters – especially those alternative minimum tax created by shuffl ing fi nancial assets and lia- bilities among countries – have become quite is on track to ensnare elaborate, and diffi cult to control.

29 million households laying the groundwork in an expanded paper- for reform Neither principled tax policy development work nightmare by 2010. nor forthright budget containment is going to happen without dedicated champions. licans must make common cause with some Some of that leadership must come from the Democrats, and the White House must make president and the heads of the House Ways common cause with Congress. Most impor- and Means and Senate Finance committees. tant, elected offi cials must see more political But passing the buck to the leadership isn’t risk in inaction than in action. enough to get the job done. The route to tax At this point, neither President Bush reform in 1986 was paved by an agreement nor Congressional proponents of tax over- between major fi gures in both parties that haul have put forward reform concepts something had to be done, and the starting

mark anderson mark with enough oomph to prompt these align- point for action would be studies or analyses

First Quarter 2005 25 tax and budget reform ious tax policy programs. When I came to prepared by Treasury Department and Joint Washington in the mid-1970s, the Treasury Committee on Taxation staff members based had a reputation for forthrightly articulat- upon principles of taxation. ing the problems with any proposal backed It will be tempting to turn to a blue rib- by members of Congress, even at the risk of bon commission to pave the way for reform, offending them. Since then, the Department but a commission’s limits should be under- has grown increasingly afraid to take stands. stood up front. A commission by itself sim- Who, if not the Treasury, will represent the ply can’t supply the leadership needed, while public, especially since most other executive- much of the detail work requires hands-on branch departments – like Commerce and assistance from Treasury and Congressional Defense – are organized to carry water for staff members. Moreover, the record of past specifi c constituencies? commissions suggests that success is hardly a The Offi ce of Management and Budget sure thing. The best have appointees who are must be restored to pre-eminent status with- willing to make hard choices and to entertain in the Executive Branch, with the capability political compromise. But even then, there to deal with budget issues that straddle agen- must be some consensus on which tax prob- cy turf. Its too-small economic staff must lems are going to be addressed, along with a be built up to resemble those of the Congres- willingness on the part of elected offi cials to sional Budget Offi ce and the Offi ce of take some political chances. Tax Analysis in the Treasury Department, While there is no surefi re means to create equipped to examine the innards of programs a climate that will support traditional tax and ranging from health care to pensions, and di- budget principles, there are ways to strength- rected to look at both direct expenditures and en the governmental institutions and process- tax expenditures. Like the Treasury, OMB es so opportunities for reform can be seized should be known for issuing studies on which when they come. programs work and which don’t. Those stud- The IRS, which has done a very poor job of ies should supplement ones put forward to examining the effectiveness of the programs support the presidential agenda. and policies it administers, needs to strength- The House Ways and Means and Sen- en its tracking and accountability procedures. ate Finance committees must restore the tra- It should assemble data and perform stud- dition of bipartisan internal meetings and ies on compliance; the distribution of pro- retreats on key issues of concern. They need gram benefi ts and at least minimal measures to make sure that disinterested researchers of effectiveness like who gets what. Unfortu- and staff members, including their own Joint nately, even after its touted modernization Committee on Taxation staff, are able to tes- that began in 1996, the IRS still does not pro- tify and get more face time with members. fi le the benefi ciaries of a multitude of key tax The committees must also give greater weight breaks, ranging from charitable contributions to internal rules that require analysis of the of appreciated property to enterprise and complexity of bills before they come to a vote. empowerment zones. Almost everyone who had a hand in creat- The Treasury Department, in turn, has an ing the business tax bill enacted in late 2004 obligation to furnish the public with infor- admits that the nation’s legislative machinery mation on the successes and failures of var- must be fi xed. Lobbyists in Washington joked

26 The Milken Institute Review Both systemic reform and deficit cutting demand leadership in identifying who is going to pay the price for civilized society.

that “if you didn’t get anything in that bill, get rules need to apply also to both automatic you really weren’t much of a lobbyist.” Not growth in entitlements and tax subsidies. only must more-objective experts have a seat at the table, they must once again provide the ariadne’s thread fi rst drafts. I still think we can get out of this maze. At Finally, Congressional budget commit- some point, reform will become more viable tees should be empowered to develop and than the alternatives. What will force budget enforce rules that limit the long-term bud- action is the popularity of programs affecting getary impact of initiatives. Sunset clauses, education, jobs, community development, the which require a program to end unless law- environment and other areas, which are slated makers later decide otherwise, should be to all but disappear if current trends contin- used to force Congress periodically to recon- ue. On the tax front, the best hope for reform sider programs, but not to hide the price tag is probably the bad will created by the com- of permanent programs by keeping all but plexity and increasing bite of the alternate the cost of the fi rst few years off the books. minimum tax. Indeed, that tax could be the The 1990 budget rules worked fairly well for horse on which the broader package rides. almost a decade and helped balance the bud- Most of all, elected offi cials are going to get temporarily, so there is a recent prece- have to gear their processes to make very dif- dent that augurs success. But since these rules ferent types of choices than they have made covered only growth through new legislation lately. The legislative ledger is quickly fi lling and not the built-in growth of old legislation, with requirements for both systemic reform and since entitlements impose even larger and defi cit cutting, and both demand lead- relative burdens today, the old rules simply ership in identifying who is going to pay the M mark anderson mark don’t cover enough of the budget. New bud- price for civilized society.

First Quarter 2005 27