Tuesday, March 27, 2012

The Challenge of Tax Reform

Paul Ryan's budget proposals are being excoriated by the left. His push for reform is of course laudable, but we should acknowledge that there are some difficulties with the approach he has taken. First the good stuff.
Mr. Ryan wants to avoid a tax increase and reform the tax code because he realizes that the budget will never balance over the long term without economic growth faster than today's 2% a year.
. . .
He has also issued a second budget estimate based on evidence from the 1960s, 1980s and 2000s that tax reform and spending restraint will increase GDP by about 0.5 to one percentage point a year. This means the Ryan budget reduces the debt to GDP ratio to 50% in 10 years from 74.2% this year (and heading higher) and thus steers the U.S. away from the Greek fiscal rocks.
. . .
But what really matters on spending over the long term is entitlement reform, and on that score Mr. Ryan goes further than any Republican Congress or President since 1995. He understands that without converting Medicare into a market-based program with more choices for seniors, and without devolving Medicaid to the states and repealing ObamaCare, tax increases will soon become the political default option.
I agree that reforming entitlements, including social security, not just medicare and medicaid are necessary elements of reform. The Rebublican party needs more Congressman like Ryan.

Ryan proposes a simplified two tier tax system with rates of 10% and 25% and a corporate rate of 25%. He proposes to pay for this with unspecified cuts to tax loopholes. The following chart from the CBO illustrates the relative size of the loopholes, aka tax expenditures, on the budget in GDP percent.

The problem is that every one of these deduction/credits are very popular. What do Republicans propose to remove to make up for the lowered rates? According to Ruth Marcus at the Washington Post, there are about $12 trillion over ten years in such "tax expenditures" and Ryan needs $4.6 trillion over the same period to keep revenue static. However, I'm not sure revenue needs to be static, since Ryan's goal is to reduce the federal government's size to under 20% as it has historically been. Even so, which deduction is the tea party supporter willing to forego?
  • Taxing health care benefits makes sense to me, but can you imagine the uproar after Obamacare is repealed or struck down and now we want make health insurance even more expensive?
  • Do we really want to discourage saving for retirement by taking 401(k) and IRA savings?
  • Mortgage interest is very powerful in propping up the prices of homes.
  • What about long term capital gains? Don't we want to encourage investing?
  • How about state taxes? Doesn't seem fair to pay taxes on money that was taken away by taxes.
  • Charitable giving? How are we going to show that we need less government if charities don't step up.

These are tough calls. My belief is that we are going to have to go for a package deal that persuades people that they are better off without the deductions in return for lower rates and growth.


  1. Isn't charity taken out of what you owe? I've never hit a high enough bracket to use itemized deductions, but that's my impression.

    If we're going to tax people on income, why not turn these deductions into deductions from income, rather than tax owed? Ditto on health insurance, count it as income based on what the employer pays, and minus any you pay.

  2. I'm crazy enough to not be big on claiming tax credits for charity, just because of the whole being-rewarded-for-what-you-did on earth part, but I also want it to be possible for folks like the Cheneys to give away most of their income without having to pay taxes on it.