When politicians show up at a manufacturer’s research centre and a family bakery, they are usually chasing votes. Max Baucus and Dave Camp were on a different sort of campaign when they hit the Minneapolis area on July 8th. Mr Baucus, a Democratic senator, and Mr Camp, a Republican congressman, are touring the nation to drum up support for tax reform.
Policy wonks have long dreamed of simplifying America’s tax code. Hopes soared after last year’s election, when Barack Obama and John Boehner, the Republican Speaker of the House of Representatives, both suggested that tax reform could be part of a grand bargain that raised tax revenue, curbed spending and cut the deficit. Alas, negotiations between the two men foundered.
However, Mr Baucus and Mr Camp, who head the tax-writing committees in their respective chambers, have not given up. For both, it is a crusade. Mr Baucus will retire at the end of 2014; tax reform would cap his long career. He has held 30 hearings in three years and published ten papers detailing options for reform.
Mr Camp’s clock is ticking, too: his term as chairman of the Ways and Means Committee ends next year. Mr Camp took up the cause in 2010. Since then he has published three draft proposals on tax reform, held 20 hearings and formed 11 working groups. The two men meet weekly, have a joint Twitter feed and now travel together.
Both want to address the tax code’s two big problems. First, it is inefficient: it imposes high marginal rates on individual and corporate income, which discourages work and investment, but it leaks a colossal $1.1 trillion a year through countless deductions, exemptions and credits. (To put that in perspective, total federal tax revenues are only $2.8 trillion.) These loopholes and deductions, (collectively known as “tax expenditures”) distort the economy by favouring some activities at others’ expense. The mortgage-interest deduction, for example, encourages Americans to borrow money and buy huge houses. The deduction for employer health insurance encourages wasteful health spending.
Too High and Full of Holes
Corporate-tax rates are the highest in the rich world: add state and local taxes to the 35% federal rate and they reach 39.2%. Yet thanks to tax breaks, they generate surprisingly little revenue. Accountants find creative ways to shift income to low-tax countries. How much tax companies actually pay varies wildly, depending on their ability to exploit loopholes and stash money abroad. Even Mr Obama agrees that the corporate rate should be lowered. This creates pressure to chop the top individual rate of 39.6% as well; otherwise businessfolk who file as individuals would incorporate to pay the lower rate.
The second problem is that the tax code is maddeningly complex. It is 4m words long and changes, on average, once a day. A 90-page booklet from the Internal Revenue Service is necessary to explain the 15 different tax incentives for higher education. There are 42 different definitions of a small business. And so on.
Mr Camp wants to produce a bill by the end of the year. He proposes to cap the corporate and individual rate at 25%, exempt most foreign profits from American tax (with safeguards to stop firms shifting intellectual-property income to tax havens), provide more uniform tax treatment of financial derivatives and simplify how businesses pay tax at individual rates.
Mr Baucus offers less detail but a bold approach. He and the top Republican on his committee have proposed starting with no tax expenditures whatsoever, and have asked other finance-committee members to say which giveaways and loopholes they wish to restore, reminding them how much higher that would raise tax rates.
Success looks elusive, however. Each loophole that is closed will hurt a clearly-defined group of voters or companies, many of them well-organised. A non-partisan summary of all the suggestions received by Mr Camp’s working groups found that most wanted to preserve and even expand existing tax breaks.
The other hurdle is deciding whether tax reform should raise new revenue. Mr Baucus says yes. Mr Camp says no; he wants to use every dollar raised by closing loopholes to reduce rates. Mr Camp and Mr Baucus are both pragmatic centrists, so they could probably forge an agreement. But their parties are another matter.
Republican leaders, having reluctantly agreed to higher taxes in January, are adamant that they will not do so again. As for the Democrats, few are passionate about tax reform except as a way to raise more money. White House support is critical. Yet Mr Obama’s idea of tax reform is to raise nearly $600 billion over the next decade by limiting tax breaks without lowering rates. Mr Baucus voted against his own party’s budget resolution in March because its proposed tax hikes were “too much”. Still, he admits that without new revenue, tax reform is “nearly impossible”.
The best opportunity for reform may come in October, when the Treasury again hits its legal borrowing limit (the “debt ceiling”). Mr Baucus and Mr Camp may try to make raising the ceiling conditional either on tax reform or a fast-track process for it. Mr Obama, however, insists that the ceiling must be raised unconditionally.
Optimists hope the appeal of tax reform could be the catalyst for a grand bargain, with Republicans accepting higher tax revenues and Democrats agreeing to curb the growth of entitlement programmes such as Social Security and Medicare (pensions and health care for the elderly). That would put America on the path to simpler taxes and sound finances. But don’t hold your breath.
© The Economist Newspaper Limited, London (July 13, 2013)