The Spirit of Tax Reform Past

Published in Barron's Magazine

Tax reform in 2014? No way! Experts said the same in 1985 and were surprised to see the Tax Reform Act of 1986 signed into law. Tax reform is a perennial interest in Washington. It rises from the ashes whenever the time is right, and no real expert should ever declare it dead.

The 1986 tax-reform effort is an interesting story with many lessons for today. The fundamental idea of lowering rates by eliminating unjustified deductions and exemptions is politically powerful.

While Americans never thought the income tax they paid was fair, comprehensive tax reform was hardly mentioned on the 1984 campaign stump. Nor was it originally on the agenda of President Ronald Reagan and the new Congress in 1985.

But tax reform was not an overnight phenomenon. Discontent was widespread in the public conversation, the business community, and the policy world. Democrats were upset with “loopholes,” and Republicans wanted lower tax rates.

Bipartisan leadership came from Reagan, Democratic Ways and Means Chairman Dan Rostenkowski of Illinois and Senate Finance Committee Chairman Bob Packwood, a Republican of Oregon. They had different political interests, but each was in search of a legacy.

Taxation is a messy and ugly legislative endeavor. Tax-cutters and revenue enhancers include idealists and pragmatists. Some seek fairness; others seek advantage for favored constituents. While everybody praises simplicity, satisfying interests creates complexity.

Despite and because of ugly backroom deals, the leaders pulled together a deal—which fell apart several times.

At one stage, when hope was nearly gone, Packwood and his top aide decided to make the plan bigger and riskier. They proposed slashing the top tax rate from 50% to 28%, which was even lower than Reagan’s proposed 35%. This gave them leverage against entrenched special interests by making their favorite tax breaks less valuable. The plan was risky, but it worked, and the 1986 Tax Reform Act passed the Senate Finance Committee unanimously.

In the end, there was a grand compromise to broaden the tax base by closing loopholes and to nurture economic growth with lower tax rates. Congressional leaders kept their parties together, and Reagan, who was not a tax expert, sold it to the public. It was a delicate house of cards that no one—not even the Reagan administration—loved, but it contained enough compromise to go the distance.

In the decades since the Tax Reform Act of 1986, the compromise has unraveled. Rates are higher, and loopholes are bigger. The income tax has not been able to withstand the political demand for popular tax breaks and the fiscal imperative of raising revenue to finance new programs.

This time, true tax reform should be sought in a new tax that rewards savings and investment, and taxes all forms of consumption. Whether or not reformers can go that far, the experience of the 1986 Act offers several lessons for success:
1) Leadership is a prerequisite. Today, House Republican Ways and Means Chairman David Camp and Senate Democrat Finance Committee Chairman Max Baucus are resolute in their determination for tax reform.

2) A vehicle and a sparkplug are imperative. Today, a fiscal grand bargain with an overhaul of the tax code as an integral component is the available vehicle. The sparkplug isn’t likely to be bipartisan leadership, as in 1986, but it could be a political response to a sudden drop in the financial markets, just as the 2008 market crisis prompted Washington into action.

3) Congress should adopt “dynamic scoring.” Today, it is more important than ever to estimate the real impact of tax-law changes on the economy and government revenues. This would be a big plus for tax reform.

4) Politically active investors must remember, “If you aren’t at the table, you could be on the menu.” Investor, beware: Low taxes on saving and investment are often mislabeled as “loopholes” or “special interest” tax breaks.

5) Never give up: Once tax reform is launched, anything can happen. It can die a thousand deaths, and be reborn, over and over and again.

MARK BLOOMFIELD is President of the American Council for Capital Formation in Washington, D.C. (www.accf.org).

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