A Missed Chance for Tax Reform

How bipartisan efforts to fix the broken tax code got swept aside by debt deal rancor

Practically the only thing that looks certain about the contentious and seemingly endless negotiations to raise the national debt ceiling is that whatever deal is finally struck will fall far short of what might have been. Cynics will point out that the same could apply to nearly everything Washington does. But the occasion of the limit's approach, and the crisis mentality that has arisen over the size of the debt, provided a rare opportunity to reform the tax code, and possibly Medicare, Medicaid, and Social Security.

Tax reform should theoretically be the easiest to achieve. Contrary to popular myth, bipartisan agreement is not so hard to find in Washington, so long as the question is limited to what needs fixing and not how to fix it. Most Republicans and Democrats agree that the federal tax code is a mess: unwieldy, inefficient, and polluted with the accrual of years' worth of special-interest breaks. A substantial cottage industry exists to churn out reports and fill blue-ribbon commissions urging reforms (and then to lament that these reforms are never implemented). What they all share is the conclusion that closing loopholes and ending tax breaks would save enough money to reduce individual and corporate rates, thereby offering something for everyone: for Republicans lower taxes and for Democrats a broader, more equitable tax base to fund the government.

This past spring, the president's fiscal commission was the latest to propose scaling back or eliminating tax expenditures (deductions, credits, exemptions) as a means of lowering rates and cutting the deficit. As its executive director, Bruce Reed, pointed out, revenue foregone through loopholes and deductions ($1.1 trillion) has grown to the point where it now eclipses the revenue that the government actually does collect ($1 trillion). "The current tax code is more holes than cheese,'' he said.

The reason these expenditures haven't been eliminated is that most of them are popular. And the most popular ones are also the largest. They include deductions for home-mortgage interest, charitable giving, state and local taxes, and the exclusion of employer-provided health insurance. Even in the best of times, the thought of cutting such deductions would terrify most politicians, which is a big reason why the last meaningful reform happened 25 years ago. "The fundamental arithmetic of lowering rates requires you to do things that tick off lots of people who vote,'' said Keith Hennessey, the director of the National Economic Council under George W. Bush. "So if you want to scale back tax preferences, it absolutely has to be bipartisan because no party would risk doing it alone.''

Despite today's atmosphere of animosity, at least three factors above and beyond the usual ones were pushing toward a deal on reform. President Obama, facing reelection and eager to impress independents, appeared willing to concede anything for a grand bargain. Republicans, too, had motivation beyond just lowering taxes. The Bush tax cuts expire next year, so absent some agreement rates will rise. And looming ominously in the background, the credit-ratings agencies are threatening to downgrade US debt if the deficit is not substantially reduced - possibly by more than spending cuts alone could achieve.

The recent negotiations led by Vice President Biden had broached some of the lesser expenditures - such as for corporate jets and ethanol - and could have addressed the larger ones, too, had the Republicans not walked away. That ended any chance of real reform. While both the current plans to raise the debt ceiling-the Democrats' in the Senate and the Republicans' in the House - feint at tax reform, they do so by calling for yet another commission, whose recommendations probably won't get any further than the volumes that preceded them.

If any sliver of hope remains to exploit this rare opportunity for tax reform, it lies in the possibility that both plans could fail, and then - well, who knows? In a rational world, tax reform would be the first option for reducing the deficit. Of course, we don't live in such a world. But it would not be so bad if, in the world we do live in, it wound up being the last option.

Joshua Green writes a weekly column for the Boston Globe.