This column originally appeared in Tax Notes, a subscription-only publication, http://www.taxanalysts.com/ .
By Diane Lim Rogers
I'm thrilled to launch my new column for Tax Notes, which I've dubbed Taxes for a Civilized Society because I will be emphasizing the need for a civilized discussion of tax policy.
Deficit reduction is often just shorthand for encouraging fiscal responsibility -- a broad and ambitious goal that promotes a strong economy and intergenerational equity. This goal is prominent in fiscal policy circles these days. Yet the intersection of budget policy with tax policy -- namely, the crucial role that tax policy must play in reducing the deficit -- is just starting to get policymakers' attention. As the president's fiscal commission and other groups that have produced deficit reduction plans of their own have made clear, the solution to our long-term fiscal challenges will have to involve a mix of both spending cuts and revenue increases. On the tax side, raising revenue can be done more intelligently if we recognize that how we raise that revenue is important for the overall efficiency and equity of our entire system of public tax and spending programs -- the effectiveness of our fiscal policies as a whole -- and not just in the simple accounting sense of how much we reduce the deficit.
Unfortunately, the debate over how to decrease the deficit often has been reduced ideologically to a debate between Republicans, who want smaller government and think the deficit is a spending-side-only problem that should be solved with spending cuts alone (demographic trends be damned), and Democrats, who want bigger government and think the deficit problem exists mostly because of excessive tax cuts (especially those originally enacted by the previous administration) and that the deficit can be reduced mainly by raising taxes on the rich -- no matter the cost of extending those tax cuts for the 98 percent of the population known as "not rich." But this oversimplified dichotomy between the spending side and the tax side is often false. Viewing tax-side deficit reduction through the eyes of a tax analyst, one can see that we actually tax and spend through our tax system. The spending that occurs through tax expenditures means that tax-side solutions to the deficit problem need not be the Republican-created caricature of the Democratic position. Revenue increases do not have to mean raising marginal tax rates or increasing the size of government. And Democrats' proposals for their tax-side solutions need not be limited to raising tax rates on the rich to be true to the Democratic goal of progressivity.
I hope that in wearing both my tax-analyst and deficit-hawk hats in writing this column, I will encourage a more civilized discussion among policymakers and the public on using better, more civilized tax policy to reduce the deficit, which I believe is essential to preserving and improving our society.
A. Civilized Society
As someone who works on the broader issues of the federal budget and fiscal responsibility, I view tax policy in the larger context of the government's overall budget constraints and the role of government in our lives. The Oliver Wendell Holmes quote that appears above the entrance to the IRS -- "Taxes are what we pay for a civilized society" -- suggests that if we want good government, we have to be willing to pay for it. We need to ask ourselves what nature and level of public spending we want, and whether we are willing to pay for it with sufficient taxes, or whether we prefer to deficit-finance it and pass the burden along to our kids (and let them pay higher taxes later). From an equity perspective, who benefits from government spending -- including that done through the tax code -- and who should pay for it through taxes or other means? When we better understand how we all benefit from government-provided goods and services (even as we acknowledge the government's "needs to improve" performance), we can become more civilized taxpayers.
B. Civilized Tax Policy
Our knowledge about what makes for better tax policy is vital when working on deficit reduction. Public finance experts know a lot more about how to raise additional revenue in economically intelligent ways than we know about, for example, how to more effectively contain healthcare costs. Our tax system should be designed to raise more revenue in as civilized (advanced, refined -- and humane) a manner as possible. In other words, can we get smarter and better organized about tax policy? How can we reform the tax system to be more economically efficient and more equitable -- not just in the context of the system in isolation, but in terms of its contribution to the larger government budget and our economy as a whole?
Discussed below are areas in which we can improve our thinking about tax policy and on which I'll elaborate in the future:
1. Tax expenditures. The most basic role of taxation is to collect funds to pay for publicly provided goods and services, including subsidies for private-sector activities. But we also spend much of those public funds through the tax system via tax expenditures. The special provisions in our federal income tax code -- exemptions, deductions, credits, or preferential tax rates -- that reduce tax burdens on specific groups are economically analogous to direct spending and have a total cost of about $1 trillion per year -- as much as all discretionary spending combined. If we are to bring greater fiscal discipline to the federal budget, we'll need to carefully evaluate the structure of our tax system in terms of the economic merits of the various provisions, weighing costs against benefits, just as we do when evaluating spending-side programs. Are the tax expenditures justified as having higher net benefits than other spending programs that are being cut? In some cases, are we actually promoting specific activities via tax expenditures that run counter to other fiscal policy goals? If budget analysts started accounting for the longer-term growth of different types of tax entitlements just as we project the growth of different categories of more traditionally defined discretionary and mandatory spending, we would likely find these tax preferences are some of the fastest-growing components of federal spending. And because tax expenditures are created by cutting holes out of a progressive income tax base, their benefits go disproportionately to higher-income households, making them a more palatable target for cuts than most other forms of spending.
2. Supply-side tax policy for economic growth. Constructing smart tax policy within the broader context of fiscal responsibility requires recognizing the connections and tradeoffs between tax rates, tax bases, revenues, public and private saving, and economic growth. The theory behind supply-side tax policy suggests that reducing tax rates encourages taxpayers to work and save and thus is good for the size of the tax base and for revenues. But in practice, tax cuts rarely pay for themselves, as the more extreme Laffer curve version of supply-side economics would suggest. We experienced higher revenues and budget surpluses following the tax rate increases enacted under the Clinton administration and lower revenues and high deficits following the tax cuts under the George W. Bush administration. In looking for economically efficient ways to raise revenue, there's room to improve the existing income tax base before we play around with the rate structure or add new tax bases. A tax cut needs to do more than provide just some marginal benefit; there must be enough benefit to make the cut worth its cost, relative to competing demands. If reducing tax rates encourages economic activity but doesn't pay for itself (such as with a rate cut that increases the deficit more than it encourages private saving), it's not necessarily good for the economy.
C. Civilized Conversations
Talking about taxes is tough business, particularly within a political setting. The reason we have a tax system that is inefficient in favoring some industries and activities over others and raises insufficient revenue is because handing out goodies -- whether to narrowly defined groups or to all -- is politically popular. Revenue-neutral tax reform has to create at least some clear losers. Revenue-gaining tax reform that is needed to address our fiscal challenges seems to create even more losers. Policymakers who are also politicians won't be willing to propose those changes unless they learn how to focus on the social benefits from reform and their political rivals begin to share this perspective on tax policy.
Politeness is key to achieve bipartisan compromise on these difficult policy choices. Disagreeing over substance is fine -- and to be expected -- but being disagreeable just for show is not. Too many fiscal policy debates over the past decade have been of the ideological blame game or "attack and cower" variety, with politicians lashing out at the other side's proposals and then refusing to provide an alternative of their own. (It's the "just say no" strategy.) Engaging in civil discussions, both among the politicians and policymakers and between those policy leaders and the general public, will make it more likely that optimal policies are achieved. Part of what I hope to do in this column is to provide some of the script for those conversations, emphasizing the too-often-neglected common ground between the political parties on tax policy and the social gains to be had in pursuing tax reform that would raise revenue and reduce the budget deficit.
So I hope Tax Notes readers will enjoy my perspective on making better tax policy and what I see as the leading role it will play over the next few years in getting the federal budget back on an economically sustainable track. Please stay tuned!