It May be Time for Comprehensive Tax Reform

Most of the talk about “taxes” these days is about “no new taxes”, but two Rice University economics professors have issued a paper saying the time is right to think about comprehensive tax reform.

Rod Rice reports.

The professors are John Diamond and George Zodrow with the Baker Institute for Public Policy. The last major tax reform was in 19-86. Their paper says the conditions that lead to that overhaul exist today. Mainly, a widespread disgust with the current system due to things like tax shelters that enable the wealthy to avoid taxes, high rates that hamper economic growth and a tax code so complex administrative and compliance costs are high. George Zodrow says the overall theme for their reform is broad based with low rates.

“The broad based part basically means to try to eliminate as many, what economists call, tax preferences or tax expenditures in the system and that allows you to lower the rates which are applied to a broader base.”

Zodrow says it’s even more important to eliminate preferences and lower rates for businesses.

“A complicating factor at the business level is that if you have a high statutory rate, then firms are very clever at what economists call “income shifting”. There able to shift income from high tax jurisdictions like the United States to other lower tax jurisdictions, and the higher your tax rates the greater the incentive for income shifting.”

An interview with both professors conducted by the Baker Institute.

Getting rid of preference is essential for reform because Zodrow says that’s where the money is. Things like the home mortgage interest deduction, the state and local tax deduction and the exclusion of employer provided health insurance premiums from income must be addressed or the base wouldn’t be broadened and therefore rates could not be lowered. But he admits this would be tough.

“It may be true to eliminate, say the mortgage interest deduction. And so for example the tax reform proposal put forth in 2005 recommended a cap to the deduction and converting to a credit.”

Zodrow says look how popular the first time home buyers credit was as compared to the mortgage interest deduction that low and many middle income homeowners get no benefit from because they don’t itemize their federal taxes. Another example would be to reform charitable deductions. It may politically impossible to remove it altogether but you may be able to target it to big contributions.

“For the run of the mill contribution that almost everyone makes you wouldn’t get a deduction for those, but if you do make a sizeable contribution in excess of 2% of AGI, adjusted gross income, then you would get either a deduction or credit, a fixed rate credit would limit the cost of that provision.”

The paper says tax reform would also simplify the tax system, however that has always been the first thing politicians say they want to do and the first thing that goes by the board.

Is comprehensive tax reform politically possible now? Diamond and Zodrow believe it is because in 19-86 control of Congress was split and the political atmosphere was highly partisan, but with leadership the tax system was reformed.