Broaden The Base, Lower The Rates May Sound Good But Never Works Long Term

As the midnight hour approaches for filing your taxes, I wanted to talk about a Leonard Lopate interview with Washington Post reporter T.R. Reid who has written a book advocating a total revamping of our tax system.

Reid points out that our tax code has been massively overhauled every 32 years, starting in 1922, again in 1954, and finally in 1986. If things hold true to form, then 2018 should be the year to do it again. And it seemed with the ascension of Trump and Republican control of the legislature, we were on track to do it again. But Trump's incompetence and the war within the GOP caucus makes the possibilities of that happening more remote.

But Reid makes the important point that it takes about 20 or 20 years of legislating special tax breaks and exemptions for specific industries, companies, or policies until the tax code becomes unmanageable. And we are clearly at that point again.

In general, tax overhaul has usually involved eliminating deductions and exemptions. By doing so, you can raise more revenue and therefore you can lower the rates. Reid's term for this is BBLR, which stands for Broaden the Base, Lower the Rates. He notes that the 1986 tax reform bill eliminated many deductions, lowered the rates, and still brought in as much or more money than before. If you count the tax credits in current tax law as actual government spending instead, it would be the largest expenditure in the US budget, coming in at $1.17 trillion.

And it is an appealing idea. He points to New Zealand where there are virtually no deductions or exemptions and where the top rate is only 17%. In addition, with hardly any deductions available and a simpler tax code, most Americans could actually do their own taxes. In fact, in Japan and the UK, the government actually has all the information about your taxes already and merely sends you a completed form. Your obligation is to check that form and accept it or make the necessary changes. But most of the time, the government's number are correct. Tax returns in Japan usually take about 5 minutes to complete.

Here in the US, the IRS could perform the same function for the majority of US taxpayers, saving millions of us time and money. But that idea is continually blocked by Congress that caves in to the pressure from the tax prep industry, primarily H&R Block and Intuit, maker of the TurboTax program. Those companies complain that it would be "unfair competition" from the government should the IRS do that.

Reid makes it very clear that lowering the rates alone does not do the trick. It must be accompanied by broadening the base. He says, "The idea that you can cut tax rates and bring in more revenue sounds great but it just doesn’t work". And he is a strong believer in the graduated rates that we have, saying we should be taxing those groups that can best afford it. As he admits, the two greatest boom periods in the postwar US economy were the 1950s and the 1990s. In the 1950s, the top rate was 90% and taxes were raised twice in the 1990s. Higher tax rates are not incompatible with strong economic growth and anecdotally they may even help create a stronger economy.

I guess at this point it is important to point out that when he says the top rate is 90%, that does not mean that the highest earners' entire income was taxed at that rate. That rate only applies to income above a certain threshold amount. He tells the possibly apocryphal story of Ronald Reagan not working after October because he would only make 10% of a new income he got at that point.

But even so, Reid offers a truly pathetic reason for not wanting to revert to the confiscatory tax rates of the 1950s. Says Reid, "I like the idea of lower rates; it just makes things simpler and people are more likely to comply…the lower the rates, …the more people are willing to pay the tax they owe". Well, he may like the idea of lower rates but higher rates will not only bring in more revenue but will also reduce income inequality. And his point about tax compliance is ridiculous when his plan envisions the IRS essentially calculating your taxes for you. If they already know your income and what you owe, how is compliance an issue. And the highest rates will only kick in for the super rich and their highest level of earnings, leaving that vast majority of Americans unaffected.

But the real flaw in Reid's approach is that he never deals with the problem he identified to begin with. Sure we can eliminate a boatload of deductions and broaden the base and that will allow us to lower the rates. But history and Reid himself has shown that corporate influence will load that tax code up with specific breaks over the next 20 or 30 years, putting a greater squeeze on federal revenue. That is especially true these days when corporate influence over elections is so strong. In the end, we will just be left with lower rates for the highest earners and less revenue over all. So there is really no long-term upside for his plan. Just like the flat tax and the idea that lower rates raises more revenue, BBLR sounds like a great idea but it never works in practice.