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The Price of Meaningful Tax Reform 

Peter Lefkin 

 

4/9/2014 

Peter Lefkin, head of government and external affairs at Allianz of America, takes a look under the hood of the proposed Tax Reform Act of 2014 and why, regardless of its fate, it’s a blueprint for the future and a sobering conversation worth having.
A disposition to preserve, and an ability to improve, taken together would be my standard of a statesman”

- Edmund Burke


It would be easy to dismiss Dave Camp’s plan to reform the US tax code due to the political dysfunction in Washington. While the bill’s not perfect, it’s a huge step in the right direction, one that cuts through partisan politics to tackle the tough issues. And it’s rooted in the sacrifices we must make for the good of the nation.

The proposed bill, the Tax Reform Act of 2014, outlines the political and economic tradeoff needed to achieve the first tax code overhaul since 1986. Camp (R-Mich.), chairman of the House Ways and Means Committee, spent three years working with former chairman of the Senate Finance Committee Max Baucus (D-Mont.) Both men were intent on finding a way to overhaul the 80,000-page tax code in a way that would lower tax rates, but bring in more revenue. How? By broadening the types of income that could be taxed and reducing the number of tax deductions for companies.

The basic framework of his plan captures the key concepts that have been bandied about for the past 20 years: lower tax rates, a simplified code with fewer loopholes, deductions and credits, as well as an expansion of the tax base to include a broader range of income types that would offset lower tax rates. Yet, in a revenue-neutral way.

Going Against the Grain

The Camp draft sought to reduce the highest tax rate for individuals and corporations to 25%; a move that everyone, including Camp, would agree was ambitious. He fought back against a variety of popular items in the tax code that people, or at least those who benefit from them, really like. This includes strong limitations on the amount of home mortgage interest that can be deducted, eliminating state and local tax deductions and scrapping deductions for interest on student loans.

Also being hit is the charitable deduction for individual taxpayers. While still permitted under Camp’s proposal, the deduction would only kick in after taxpayers meet the threshold of 2% of their adjusted gross income. In the unlikely event his proposal becomes law, the top rate for individuals would fall from 39.6% to 25%, although a 10% surcharge would apply to the nation’s highest income taxpayers. Upper-income individuals would also be obligated to pay taxes on their employer-sponsored health care benefits. All of these reforms are designed to dissuade people from itemizing their deductions in favor of taking the standard deduction, which Camp proposes to increase to $11,000 from the current $6,100.

The Impact on Job Growth

Business groups have long argued that the current 35% tax rate in the United States is the highest in the industrialized world, and that it’s a big reason why so many jobs, particularly in manufacturing, have been lost. However, to get to the 25% rate, a lot of their favorite deductions would be impacted too, including those related to advertising expenses, stock options and the oil depletion allowance.

For example, large banks would face a new tax on assets in excess of $500 billion dollars and for all companies, depreciation schedules would have to slow down. Investment fund managers would be taxed at the higher ordinary tax rate rather than the capital gains rate. Meanwhile, life insurers would face higher tax obligations from a host of provisions that would negatively impact the life insurance industry.

Not surprisingly, Camp faced significant resistance from his own Republican Caucus, which felt that the draft would turn attention away from the ongoing issues the Obama administration has had implementing the Affordable Care Act. With November mid-term elections just months away, Republicans smell victory. They could win control of the Senate by picking up six or more seats, while adding to their majority in the House of Representatives.

Addressing Cynicism

The conventional wisdom in Washington is that tax reform is a politically appealing issue in the abstract, but not when you get into the details. Individuals and corporations like their tax preferences and are skeptical when you tell them that they will be in roughly the same situation—and possibly a better one—if their tax breaks are eliminated.

Indeed, cynicism reigns supreme among Americans who fear that they will lose their tax deductions. And even if they get the lower rates, they believe it will only be temporary. To a certain degree, that’s been the history of the Tax Reform Act of 1986, the last comprehensive tax package enacted. In that case, rates fell from 50% to 28% for individuals, only to jump back up to 39% by 1993.

Sure, we can all poke holes in the Camp bill. (Hopefully, those involving the taxation of insurance companies and asset managers.) However, he has done the nation a great service by putting it out there in an actual document that shows the political and economic tradeoffs needed to reform the tax code. It’s sobering but nonetheless highlights the kind of tough decisions that need to be made to bring about meaningful change.

What Went Wrong

In the mid-1980s, as a young lobbyist with the American Insurance Association, I did some work on the 1986 tax law. And I have watched it unravel over the past 28 years due to competing demands of needing revenue to accelerate the economy, a tendency for Congress and the president to use the tax code to promote societal goals, and to curry favor with a preferred constituency.

Over the years, many people have proposed alternatives, all of which promise to make the tax code less complex and reduce rates, but only promising to fill in the details later. These include Congressman Armey’s flat tax and Congressman Linder’s Fair Tax in the 1990’s, Republican Presidential hopeful Herman Cain’s 9-9-9 plan in 2012, and Republican presidential nominee Mitt Romney’s proposal. All of them offered what something removed from the political realities of Washington. And they were all probably in line with public discourse on conquering “waste, fraud and abuse’ in order to solve the nation’s deficit problems. But they lacked specifics.

Undoubtedly, funding the US government is a difficult task, one that’s exacerbated by the fact that entitlement spending—Social Security, Medicare and Medicaid—are all but certain to rise precipitously in the next 10 years. Rising costs stem from more baby boomers entering retirement and the expansion of health-care coverage under the Obama health-care law.

Unfortunately, time is probably running short for Camp. His term as the senior Republican on the Ways and Means Committee is limited to six years. He will be forced give up his gavel in 2015. Sadly, his proposal is all but certain to languish in Committee and nobody, including me, expects Congress to move the legislation forward.

A Blueprint for the Future

There are plenty of places to point blame for this year’s almost certain failure to enact tax reform. First, when it last occurred in 1986, President Reagan used his bully pulpit to secure public support. In contrast, President Obama aside from having other priorities and and facing lame-duck status, the lack of political trust between his administration and congressional Republicans make almost any bill, even those with some bipartisan support, extremely difficult to turn into law.

Second, congressional Democrats were never very enthusiastic about reforming the tax code and Congressional Republicans liked the rhetoric better than the potential details. With the 2014 Congressional campaign starting early, Republicans want to focus on health care. Therefore, Camp is not in a position to get much support with moving his proposal from his party’s leadership.

Nevertheless, Congressman Camp deserves our praise. He has left his legacy by producing a document that shows the American people and public officials who ask for and promise tax reform the types of trade-offs necessary to meet their demands and keep their word. In the end, or at least for now, they may or may not decide that it’s worth it.

Still, it’s comforting to hear a well-respected member of Congress be honest with the public by telling them, that on tax reform and other elements of public policy, there is no such thing as a free lunch. It will hopefully invite the type of spirited and useful debate that is needed when highly technical issues are being addressed. Politicians hate to ask the voter to make tough choices, and while this probably gets them reelected, it also has helped assure a brand of voter cynicism that’s not healthy for our government.




The material contains the current opinions of the author, which are subject to change without notice. Statements concerning financial market trends are based on current market conditions, which will fluctuate. References to specific securities and issuers are for illustrative purposes only and are not intended to be, and should not be interpreted as, recommendations to purchase or sell such securities. Forecasts and estimates have certain inherent limitations, and are not intended to be relied upon as advice or interpreted as a recommendation.

 

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