Max Baucus, the Senate’s top tax writer and a member of the bipartisan super committee, told his fellow committee members that federal tax reform is often more complicated than assumed.
NEW YORK (CNNMoney) — For many in Washington, it’s an article of faith: Tax reform = economic growth.
Not only will federal tax reform simplify and modernize an overly complex and outdated tax system. It will boost the economy, too. And you know what that means: Jobs, jobs, jobs.
“This is the most pro-growth thing we can do, to fundamentally reform our tax code,” said Sen. Pat Toomey, a Republican member of the congressional super committee charged with reducing deficits.
Unfortunately, it’s not so simple: There just isn’t a straight line between tax reform and job creation.
It’s hard to argue that the federal tax code shouldn’t be reformed. It is unwieldy, unpredictable and costly to comply with. And even the strangest of bedfellows perceive it to be unfair. (See what the President Obama’s debt commission proposed.)
Like Toomey, many economists and tax experts believe the economy could be helped if lawmakers lowered income tax rates and eliminated or shrank many of the code’s tax breaks to pay for the rate reduction.
Their theory: People would start to put their money into activities and investments where it makes the best economic sense rather than where they can get the best tax break.
“You remove the opportunity for inefficient tax avoidance,” said Len Burman, who worked at the Treasury Department during the Clinton Administration and is former director of the nonpartisan Tax Policy Center.
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“But the real question is how much faster the economy would grow. That’s up in the air,” Burman added.
It’s up in the air for several reasons.
First, it’s hard to isolate the effects of tax reform on economic growth, since many other factors also play a role in spurring or slowing the economy.
Second, reforming the code means doing things that may work at cross purposes, which could minimize or negate economic growth effects.
Say, for example, lawmakers choose to help pay for a reduction in the top corporate tax rate by eliminating accelerated depreciation. One of the biggest breaks businesses enjoy, accelerated depreciation allows companies to save even more on their tax bills by speeding up deductions for equipment purchases.
On the one hand “you’re making investment less attractive by scaling back the capital cost recovery. And on the other hand you’re making it more attractive by reducing the marginal rate on the income when it’s ultimately taxed,” Thomas Barthold, chief of staff of the Joint Committee on Taxation, told the super committee last week.
“That in itself is not automatically pro-growth, because you’re going in one direction with cost recovery and the other direction with the rate,” Barthold added.
For that reason and others, not everyone is convinced that reform will provide the growth boost everyone is hoping for.
John Buckley, former Democratic tax counsel to the House Ways and Means Committee, noted that a study conducted a decade after the enactment of the 1986 tax reform found that it didn’t have much of a macroeconomic effect at all — positive or negative.
The reform still accomplished a lot of valuable things, such as getting rid of abusive tax shelters, he told the House Ways and Means Committee.
And Buckley believes the tax code today should be weeded of the many overlapping and unduly complex benefits for the same type of activity, such as sending a child to college or saving for retirement.
But he’s wary of a wholesale overhaul of tax breaks — particularly the largest and most popular ones such as the mortgage interest and charitable deductions. “These are imbedded in parts of our society and can’t just be yanked out,” Buckley said.
At least not without potentially negative economic consequences.
Senate Finance Chairman Max Baucus, a Democratic member of the super committee who favors broad reform, is aware of that risk.
“Often when we go down this road, it’s more complicated than we think and there are unintended consequences of major changes that we might make,” Baucus said.
On top of that, eliminating tax breaks wouldn’t necessarily bring in revenue on a dollar-for-dollar basis, Barthold said.
In other words, just because the tax code is filled with more than $1 trillion worth of tax breaks every year, eliminating them wouldn’t necessarily raise more than $1 trillion annually. That’s because tax changes will affect economic behavior plus there will be interactive effects between those changes that will affect revenue intake.
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Those are just some of the reasons it will be tricky — if not impossible — to accurately predict the potential growth effect and revenue potential of tax reform.
In the context of the debt reduction debate, it gets trickier still.
Republicans have said they don’t want tax reform to raise any more revenue than the current system. And they don’t want to earmark any of the revenue raised from eliminating tax breaks to help cut the debt. They believe that the economic growth that will result from lower rates will itself generate a lot of new revenue, which will naturally help reduce future deficits.
But counting on potential growth that no one can guarantee to help reduce debt is a tenuous strategy at best.