Eight Lessons on how to design Tax Reform


Endorsing the concept of tax reform is just one small step towards making it a reality. How do lawmakers, who are confronted with an almost infinite number of policy options cope? The lawmakers must ensure that reform serves the public in a meaningful way.
To help focus those choices, here are eight lessons that were vital to the organisation of the Department of Treasury study (“Treasury I”) that led to the Tax Reform Act of1986, the only comprehensive base-broadening tax reform in the hundred-plus year history of the income tax.
1. Know the unique requirements and opportunities of the time: No past reform is repeatable. Society today has new needs, opportunities, and challenges. For example, the 1986 reform occurred at a time when growing tax shelters were widely seen as unfair and inefficient, economic productivity was strong, and the Federal budget deficit, while then also a problem, had at least been tamed somewhat by deficit-cutting bills in 1982, 1983, and 1984. President Reagan was focused on lowering tax rates and congressional leaders like Democratic Senator Bill Bradley and Republican Representative Jack Kemp had been promoting tax reform for years.
2. Don’t try to build reform from a stack of wants: The more politicians try to organise tax reform by supporting a bunch of give-away rather than fixing flawed parts of the tax system, the less likely they are to succeed. Instead, they’ll usually end up with provisions that are costly, inconsistent, difficult to administer, and which fail to meet their stated objectives—the very opposite of reform.
3. Use principles to drive policy choices: Sponsors of tax bills, no matter how bad, want to label their work “reform.” But principles should guide where one is going and can deter consideration of items that are outside that framework. Tax policy principles should center on: equal treatment of equals; efficiency; progressivity; limits on the disincentives to work, save, or invest that are inherent in any tax; and “administrability,” or avoiding both high enforcement costs and the erosion of trust in the system that arises when cheating can’t be controlled.
4. Focus first on principles that are accepted by conservatives, liberals, and independents alike: For decades, the political parties have been fighting over two principles progressivity and avoidance of the distortions that higher tax rates create. Yet, lawmakers share many concerns about flaws in the tax system, such as needless complexity and tax preferences or subsidies that promote neither fairness nor growth. Reform should focus first on those shared concerns. After all, members of a family can work together to fix a leaky roof it even if they can’t agree on whether to spend money on a new bed or on a sofa.
5. Remember the balance sheets in the tax system and between taxes and spending in the broader budget: Nothing derails the tax reform train more than trying to give away money without simultaneously calculating who will pay the bill—whether through tax increases to offset the tax cuts, spending decreases, or rising debt and interest costs to be paid by future generations.
6. Recognise the health, housing, charity, retirement, and other policies woven into the tax code: Hundreds of billions of dollars are spent on the tax subsidy for employer-provided insurance. Housing tax subsidies exceed the entire budget of the Department of Housing and Urban Development (HUD). Overall, about one quarter of all federal subsidies are provided through the tax code, a reality that is hard to ignore even in modest reforms and impossible to avoiding comprehensive reform. To the extent these subsidies are maintained, they should be made more explicit and more cost-effective.
7. Gather evidence throughout the legislative process: Among the many reasons for success in 1986, Treasury and IRS worked hard to gather evidence on growing problems such as the tax shelters and who benefited from various provisions. Some of this work, such as building and maintaining individual and corporate tax models, requires long-term investment and staff creativity. For example, before 1984 when calculating who benefits from tax changes, tables showed taxpayers grouped by adjusted gross income (AGI) categories. As a result, when Congress curbed tax shelters, the fictitious negative partnership income from those tax-shelter investments was subtracted to calculate AGI in a way that made many rich taxpayers look poor in these tables, and if maintained would have made the forthcoming initiative subject to criticism as an attack on the poor. The methodology was fixed by making changes to the underlying approach for understanding tax burdens, the type of modification that can’t suddenly be done at the last minute.
8. Empower the professionals at Treasury’s Office of Tax Policy and the congressional Joint Committee on Taxation: These talented professional staff knows how to fix a broken tax system but can help only when their political bosses let them. For some reason, once smart doctors, lawyers, and entrepreneurs find themselves in positions of political power, they think that they have miraculously garnered the knowledge and skill to understand complicated tax provisions, the incentives they create, and the interactions among them. As a result, these policymakers tend to over-estimate their own tax reform abilities and instincts relative to the career professional staff.

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