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Tax Reform in 2013? Maybe, Maybe Not

Posted in Budget, Congress, Legislation (Federal), Tax Policy

By Joe Dowley

Joe Dowley served as Chief Counsel of the Committee on Ways & Means, U.S. House of Representatives when Congress last undertook fundamental tax reform.

Here are a few of the reasons why Congress may undertake tax reform in 2013, together with why not rebuttals:

To avoid the March 1st sequester ($100.9 billion in across-the board cuts from defense and non-defense discretionary accounts), and/or to pass appropriations to avoid a government shutdown on March 27th, leaders will agree in February on a new fiscal approach including tax reform as well as more carefully targeted spending cuts. The plan would be for both houses to agree to a budget resolution reflecting a consensus number on revenues, as well as discretionary spending cuts and a process for dealing with entitlement reforms. This has been described in the past as a “Grand Bargain”. The rationale for this is that the sequester is a mindless and damaging “nuclear” default that was never intended to take effect and will needlessly damage defense and other programs that could be cut in a wiser fashion; shutting down the government is fraught with political downsides, and costly; and a balance of significant new revenues and sufficient spending reductions is exactly what most economists say is needed to successfully bend down the upward curve of the nation’s debt. Besides, in tax reform there is the possibility of reducing individual tax rates – something voters should like, even as favored tax benefits and unpopular cuts are being made. A little sugar makes the medicine go down…

Countering this is the sense that Republicans have that they’ve “already given at the office” when it comes to new revenues, to wit: $600 billion in higher income taxes on wealthier individuals in the just-enacted ATRA. The argument is that the House Republican Conference simply won’t support tax levels above the new (current) baseline. Many Republicans would like to see tax reform happen – foremost is Chairman Dave Camp of Ways & Means – but there is concern that if the House produces a revenue-neutral bill that reduces rates by broadening the tax base, members will have taken hard votes eliminating popular tax benefits only to have the Senate produce a bill raising more revenue from the wealthy and permitting them to hammer home the theme that Republicans stand for protecting their “friends.” Rumor abounds that Speaker Boehner has admonished Rep. Camp to “go slow” on reform on this premise. Also, to date there has been zero movement on dealing with the sequester, which leads some to think that there won’t be an effort to head it off, after all.

There is a good deal of consensus around the idea of fixing the U.S. corporate tax regime, although not necessarily centered on the idea of adopting a territorial system to replace the modified world-wide system now in place. Major business associations like the Business Roundtable are agitating for reform. Many reformers see the revenue from reductions in business tax breaks and other provisions as a means of lowering overall rates both for businesses and individuals. The recently released Ways & Means discussion draft on financial products taxation is an example. If enacted it would raise significant new revenue that could be directed to lowering rates. If tax writers head down the corporate reform path, many feel that it is inevitable that individual reform will accompany the effort, if only because of the growth in business pass-through entities (taxed at the individual level) since the Tax Reform Act of 1986.

Some Democrats are not so sure that delving into the way the U.S. taxes its multi-national corporations will yield a positive result, given the head of steam built up around going to a territorial system – something the House is sure to do. In a conference with the Senate, they worry that in return for some increased level of revenues the trade-off will be a permanent change in the views of U.S. multinationals regarding the location of their operations. Some are predicting that increasingly globalized U.S. corporations will have increased incentives to move even more operations – and jobs – off-shore. Finally, members on both sides of the aisle are wary of taking hard votes to end favored tax provisions only to have the whole exercise crater due to a failure to reach an agreement in conference on the question of how much is enough revenue.

Comment: The fear of failure can have a paralyzing effect. Some of the fear can be dealt with if top leaders, including the President, agree not to go after the other side as the House and Senate reform products are being developed.  President Reagan agreed to such restraint in 1985 when the Democratic House processed its version of tax reform. In the end this facilitated production of the two bills that conferees successfully transformed into the Tax Reform Act of 1986.