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Let’s Start All Over Again

A new approach to tax reform.

Oct 17, 2011, Vol. 17, No. 05 • By ELI LEHRER and IKE BRANNON
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What didn’t catch on for federal spending, however, may have a lot of promise for simplifying the tax code. Rather than a “zero base,” a procedure for developing a better tax code would begin with what might be called a “flat base”: an assumption that the federal government would tax all income (by the broadest possible definition of income) from all sources at a level at least sufficient to maintain current levels of revenue​—​probably somewhere between 15 and 20 percent. 

All current deviations from that flat base​—​deductions, credits, rate changes, special treatment, deferrals, rebates, etc.​—​would require justification. For any deviation, evaluators would ask two questions similar to those Phyrr devised: (1) “What goal or relevance to a national government (if any) does this provision attempt to accomplish?” And (2) “Is this goal most efficiently and effectively achieved through the tax code or by some other means?” Like the fundamental questions asked by zero-base budgeters, of course, these “flat-base tax” questions would be fraught with political and ideological baggage. Nonetheless, if asked honestly and forthrightly by people of all persuasions, they might produce some surprising agreement. 

Looking at what may be the single most sacred provision in the tax code​—​the deduction for almost all mortgage interest on first and second homes​—​reveals how these two simple questions can clarify things. In response to the first question​—​what goal of the federal government does this program serve?​—​the social consensus seems to be that the government should help make homeownership affordable for people of modest means. However, on the second question​—​is the tax code the most efficient or effective way to promote homeownership?​—​the mortgage interest deduction fares quite poorly by any objective measure. Many people who benefit from the deduction right now could easily own homes even without the deduction, and for them it merely encourages the purchase of houses with extra bedrooms, hot tubs, and granite countertops. Some sort of grant program for first-time, middle-income home buyers could likely encourage home ownership more effectively and at a much lower cost to the federal treasury. 

Similar tests can be applied to nearly every part of the tax code. Such an exercise might result, for instance, in a vast simplification of the many different existing inducements to retirement savings in the tax code. Few other major features in the current tax code would make the cut. If posed in terms of national interests, most narrow provisions​—​special credits for certain water-heater designs, tax breaks for opening new oil wells, and tax rules that incentivize small businesses to buy large vehicles​—​are testaments to the power of certain lobbying groups rather than any reasonable assessment of national goals. Other far more consequential provisions, such as the limitless deductibility of employer-provided health insurance, may advance legitimate goals of the national government but, like the mortgage tax deduction, are costly ways to do so.

It goes without saying that eliminating a boatload of deductions and credits would smooth the path towards lower marginal tax rates on individuals and businesses. This, in turn, would help stimulate investment, productivity, and economic growth while reducing compliance costs. 

Developing a flat-base tax code would surely entail political compromises. In a few cases conservatives might have to support new spending programs to replace ineffective tax provisions targeted towards worthy goals. Liberals, likewise, would have to admit that certain tasks now carried out through the tax code ought not to be the federal government’s business at all.

While certainly cumbersome in the first instance​—​developing alternative scenarios for every tax code provision would probably require (temporary, one hopes) staffing increases at the Office of Management and Budget, Joint Committee on Taxation, and Congressional Budget Office​—​flat-base tax reform would simplify the overall
tax writing process going forward. If all rigorous “flat-base” tests were applied to all changes after the adoption of a new tax code, the bar special interests would have to jump to get favors from the tax man would be much higher. 

A flat-base tax reform process isn’t a panacea, of course. It won’t, by itself, disarm the special interests that now lard the tax code with narrow favors, nor will it necessarily balance the budget. At the very least, though, a fresh look at tax code provisions could point the way towards a more efficient means of funding the necessary functions of the federal government.

Eli Lehrer is vice president of the Heartland Institute. Ike Brannon is director of economic policy at the American Action Forum.

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