Some type of tax reform will probably pass this year, but I expect the same philosophical debate we saw during the Ryancare debacle. Real tax reform requires 3 things: Lower taxes, less spending, and simplification of the system. Cutting taxes is not too difficult politically. Spending reductions are feasible because a better tax code can enhance revenue anyway, while real “cuts” are delayed into the future. But simplifying the system is a real problem.
A simplified tax code is easy to understand and keeps the government out of one’s personal business. You would think simplification would be a no-brainer, but each carve-out in the existing system benefits certain individuals and interest groups at the expense of everyone else. Most taxpayers don’t realize how these arduous rules and “tax breaks” hurt all of us.
Take the home mortgage interest deduction as an example. If you itemize on your return—another needless complication of the code—then you can typically deduct from your income the interest you pay on your mortgage. Proponents of this policy claim that it “makes housing more affordable.” Who could oppose home ownership?
The mortgage interest deduction essentially reduces monthly payments, encouraging Americans to purchase homes, and to purchase larger ones. Almost everyone connected to housing from realtors to contractors will fight to the end to keep this deduction in the code because it affects their pocketbooks, at least in the short term. It’s a bad deal in the long run, as a subsidy always increases prices and encourages people to spend more than they would otherwise. In fact, this and other government (and Fed) support for housing set the table for the Great Recession.
But convincing Americans that subsidized housing hurts the economy is not easy. Many think they’re getting something out of the deal. What they don’t realize is that tax rates for everyone must be increased to compensate for the $70 billion in annual mortgage interest deductions. That’s more than $200 per American citizen, most of whom don’t file or pay income taxes anyway.
Mortgage interest is only the tip of the iceberg. There’s health care, the earned income tax credit (EITC), and solar energy, to mention a few others. Each special deduction or tax credit has its own constituency that lobbies and donates to campaigns. Try to abolish all of them at once, the insiders tell us, and you’ll have too many battles to wage. They suggest that we eliminate some of them, avoid the bloodiest fights, provide a modest tax cut, and call it a day.
I take the opposite view. I favor attacking all deductions simultaneously to allow for the greatest reduction in tax rates. Start with your income, subtract an individual deduction, multiple what’s left by a flat tax rate, and you’re done. I realize that my plan would be deemed “too radical” by most, but I’m negotiable. A few deductions like charitable contributions (which is logical) and health care (which is practical) might remain to get a bill passed, but we can eliminate most of the social engineering in the tax code if we have the courage. Unfortunately, I’m doubtful that enough Republicans do.