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The parties are at loggerheads over taxes, and no sweeping reform will please both sides.
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It would be the ultimate fiscal cliff. A group of House Republicans wants to put an expiration date on the 75,000-page U.S. tax code. The Tax Code Termination Act would require the repeal of the entire code in 2017 — except for the bits dealing with Social Security and Medicare — with a new system ready to go for the following year.
Of course, the U.S. economy would benefit from major tax reform that eliminated the current bias against investment, axed crony-capitalist tax breaks, and lowered marginal rates on individuals and business as much as possible. But Republicans can put aside any fantasies of starting 2018 with a flat income tax or a national sales tax such as the Fair Tax, two popular right-of-center alternatives to the status quo.
First, both of those sweeping reforms would likely either raise taxes on middle-class voters — including millions who currently pay no income tax — or be huge revenue losers. This is a big reason that the Romney campaign passed on these ideas.
Second, unless Republicans score a historic landslide in the 2016 presidential and congressional elections, the folks on the other side of the aisle will have a major say in any tax revamp. And the liberal vision of tax reform is starkly different and growing more so, as evidenced by the recent fight over extending the 2001 and 2003 Bush tax cuts.
Liberals start with a belief that America is severely undertaxed. Democratic politicians are loath to spell out just how high future taxes will need to rise in order to pay for the spending they want, but every now and then the truth slips out. The labor-backed Economic Policy Institute has created a long-term budget plan that would increase tax revenue from its traditional 18 percent of GDP to 24 percent of GDP by 2035. Yet even with that whopping 33 percent tax-revenue increase, the federal budget would still run large annual deficits and the overall debt burden would be higher than it is currently. It’s probably fair to say that the EPI has identified a tax floor for funding its desired level of spending rather than a ceiling.
Also making bipartisan agreement harder is the new left-of-center consensus that marginal tax rates can go dramatically higher before they weaken economic growth and become self-defeating. Economist Peter Diamond, a Nobel laureate and failed Obama nominee to the Federal Reserve Board, set the liberal blogosphere buzzing last year with a Wall Street Journal op-ed that cited his research suggesting that “raising the top tax rate is very likely to result in revenue increases at least until we reach the 50% rate that held during the first Reagan administration, and possibly until the 70% rate of the 1970s.”
But Diamond’s research is a poor model for instructing policymakers because it makes two dubious assumptions: (1) High-income taxpayers react to tax hikes more or less like lower-income taxpayers do (meaning not so much), and (2) high marginal rates have no long-term impact on economic growth. For a real-world reality check, look at what happened when Great Britain recently raised its top marginal tax rate from 40 to 50 percent. The government found it took in less tax revenue, not more.
Maybe there’s no better example of how Democrats are veering sharply from both the GOP and mainstream economics on tax reform than the reemergence of the old idea of slapping a wealth tax on the fortunes of rich Americans. In a recent column, Robert Reich, labor secretary during the Clinton administration, declared, “We should tax the vast accumulations of wealth now in the hands of a relative few.” To make his case, he cited Yale’s Bruce Ackerman and Anne Alstott, who want a 2 percent surtax on the wealth of the richest one-half of 1 percent of Americans. They calculate that it would generate $750 billion in new tax revenue over the next decade. But that static analysis ignores research suggesting that wealth taxes hurt entrepreneurial activity and economic growth.
So here’s your trouble: Republicans view tax reform as way of making the tax code more efficient and amenable to economic growth; Democrats see it as a crude tool for financing an ever-expanding welfare state. Given that philosophical chasm, expect the current mess of a tax code to stay alive and kicking for some time.
— James Pethokoukis, a columnist, blogs for the American Enterprise Institute.
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