Neither President Bush nor Sen. John Kerry talks much about how he would reform the nation’s tax code, but policy wonks are buzzing about the possibility of radical change in the next four years.
A proposal to scrap the federal income tax and replace it with a national sales tax has received renewed attention after President Bush last month called it “an interesting idea that we ought to explore seriously.” Republican leaders in the House including Speaker Dennis Hastert and Majority Leader Tom DeLay have endorsed a sales tax bill that would do nothing less than transform the nation’s consumer economy.
The bill, H.R. 25, effectively would impose a 30 percent tax on goods and services while eliminating the federal income tax and payroll taxes that fund Social Security and Medicare. (Proponents call it a 23 percent tax because the tax would be 23 percent of the final price.)
As described this week in a highly critical article by top Democratic House staff members, the bill would tax prescription drugs, food, new homes, health care services and even much of state and local government spending. The bill would attempt to protect low-income earners by exempting consumption up to the federal poverty line, or about $19,000 for a family of four.
“It’s unlike any sales tax you or I have ever seen,” said John Buckley, chief Democratic tax counsel for the Ways and Means Committee and lead author of the article in Tax Notes. “But that is what you have to do to even get close to replacing the current revenues.”
Economists at the Brookings Institution figured the tax rate would have to be closer to 60 percent over the next 10 years to fully replace all federal tax revenues including the estate tax.
Although 55 House members have signed on to support H.R. 25, nobody believes anything close to the proposal has a chance of passing in the foreseeable future. But there are good reasons to believe Congress could make sweeping changes to the tax system in coming years. For one, many provisions of the 2001 and 2003 tax cuts are scheduled to expire between now and 2010. Other time bombs are ticking too, including the alternative minimum tax, which is on track to snare 30 percent of all filers by 2010, up from about 3 percent this year.
Scott Hodge, president of the Tax Foundation, said converging events could create the “critical mass” needed to bring about tax reform. “As millions more taxpayers get thrown in the AMT, Congress and the White House are going to have to do something about it,” said Hodge. “It could create a real debate over fundamental tax reform.”
Even if a national retail sales tax is nothing more than a “curiosity,” as Hodge described it, Bush’s willingness to offer at least lip service to the idea underscores a fundamental difference in his and Kerry’s approach to tax policy.
Kerry has said little about broad tax reform, but the core domestic proposals of his campaign make it clear he favors the current progressive tax system, in which the wealthy not only absorb most of the tax burden but also pay a higher percentage of their income as taxes. In fact Kerry would increase the progressive nature of the system by reversing Bush-era tax cuts for the wealthiest 2 percent and using the proceeds to fund new programs including a college tuition tax credit and a plan to make health insurance more affordable.
Bush has made a campaign priority out of retaining the current marginal tax rates and making them permanent. And he has proposed a series of tax changes under the banner of an “ownership society” that would continue a movement away from taxing income derived from investments such as dividends and capital gains.
The Bush administration efforts have been incremental, but they add up to progress toward a long-cherished dream of some conservative tax activists toward a tax on consumption rather than income. They argue that income taxes are highly inefficient, expensive to collect, and distort economic activity through the many subsidies and exemptions in the massive U.S. tax code.
While Bush is happy to bash the tax code in speeches on the campaign stump, he and members of his administration have been careful not to issue an outright endorsement of a sales or consumption tax. They fear, with some justification, that Democrats would attack it as a tax giveaway that favors the economic elite.
In his acceptance speech at the Republican convention Bush complained about the “complicated mess” of the current tax code but he has promised only to appoint a panel that would come up with suggestions for a “simpler, fairer, pro-growth system.” No appointments would be made until after the election.
For his part Kerry also would seek expert help on the issue of tax simplification, according to campaign officials. Kerry has spelled out proposals to make substantial changes in the nation’s corporate tax structure but has not made any specific proposals on individual taxes beyond raising the top rate for the wealthiest earners.
A recent article in The New Yorker magazine described how Bush has taken a “stealthy approach” to tax reform, moving step by step toward a flattened tax structure, the antithesis of the progressive system favored by Kerry and most Democrats.
Conservative economists say there is nothing secretive about the Bush administration approach.
“These have been major fights,” said Dan Mitchell, senior economist at the Heritage Foundation. “There is no ambiguity about what Bush has been trying to do.”
He and other policy analysts say Bush has been moving haltingly in the direction of a flat tax, which is often described as equivalent to a consumption tax because it excludes individual dividend and capital gain income.
“It is safe to say there will be some continued movement toward a flat tax in a second Bush term,” he said. “It might be incremental, it might be a big jump. Will it be a pure flat tax? No, because politically that’s too difficult.”
But he and other conservatives are skeptical about Bush’s plans for broad tax reform. Chris Edwards, director of fiscal policy studies at the libertarian Cato Institute noted that the federal tax code is now 60,000 pages long, up from 40,000 when Republicans took control of Congress a decade ago.
“In the mid-1980s (former Ways and Means Chairman Bill) Archer could complain the tax code mess was the Democrats’ fault,” he said. “The problem now is that the Republicans themselves have spent the past decade putting a lot of loopholes in the tax code — like the child tax credit. So it does make it a more difficult environment.”