Tax reform does not guarantee growth
One of the few things that President Obama and Mitt Romney are likely to agree on when they debate next week is the need for tax reform. Both candidates have backed streamlining America’s crazy-quilt tax code, and both have said that reforms could boost economic growth. Meanwhile, two key congressional committees held a rare bipartisan hearing last week – with lawmakers from both parties saying that tax reform is needed to rev up the economy.
Yet exactly how and why tax reform would spur growth is far from clear. Many proponents of reform, including Romney, want to lower tax rates while retaining the same level of revenue. But doing that means reducing major individual tax breaks that subsidize key sectors of the economy – including housing and healthcare. Long term, there are good arguments for whacking such subsidies, which tilt heavily in favor of affluent households and distort our economy. But curbing these freebies doesn’t offer a short-term economic fix and, in fact, could hurt growth.
Let’s start with the best-known big tax break – the mortgage interest deduction, which will cost the U.S. Treasury about $100 billion next year, according to the Congressional Research Service. Shrinking this loophole is a good idea in principle, since it primarily benefits more affluent households who have big mortgages and itemize their taxes, but it would be a blow to a housing sector that is still struggling. Smaller subsidies for home buyers would mean weaker sales and less new construction and would keep home values depressed – not an outcome that anyone wants to see right now. Among other things, such reform could be another severe blow to construction workers, who now have the highest unemployment rate of any group.
Or consider the biggest tax expenditure of all – the exclusion of employer-provided health insurance. Thanks to this deduction, which clocks in at over $150 billion annually, the IRS doesn’t count the value of health benefits that workers get from their employers as compensation – thus providing the health sector with tens of millions of subsidized customers. This break is also heavily tilted toward the affluent, who receive better health benefits, and is a ripe target for reform – just not right now. The healthcare sector is one of the few bright spots in the economy, accounting for many of the new jobs created in recent months, according to the Bureau of Labor Statistics. Whoever is inaugurated in January won’t want to mess with this job growth.
The story is the same for most other big tax breaks. Close any loophole and somebody is going to take a hit. Even scrapping some of the most indefensible corporate tax breaks – like subsidies for energy companies – could have adverse near-term effects. Oil and gas exploration is creating a lot of jobs right now, with unemployment a mere 3 percent in the fracking boom state of North Dakota. Ending tax giveaways to this profitable industry probably won’t cost jobs – but it’s hard to imagine that any president, including Obama, really wants to test that hypothesis right now.
While the concrete costs of closing tax loopholes are easy to see, the benefits of lower rates are more speculative. Consumers and employers have been holding back even though tax rates are at a 60-year low. It’s hard to see why even lower rates would lead to more hiring or spending, as Romney’s economic blueprint assumes.
None of this is to say that tax reform isn’t a good idea. It is, and this issue commands unusual support across the ideological spectrum. Conservatives don’t like using the tax code to choose winners and losers, while progressives don’t like how the lion’s share of breaks goes to better-off households or to corporations. Amid partisan deadlock in Washington, it would be nice if Congress could actually do something big – and tax reform is the best candidate for such action.
Realistically, though, rewriting the tax code may have to wait until after the economy perks up. Closing big loopholes will be a heavy enough lift given the power of interest groups inside the Beltway. It is even less politically feasible during hard times, when no political leaders want to inflict yet more pain.
Tax reform is what Congress should do after the economy starts growing faster. It is not the way to achieve that goal.
PHOTO: The National Debt Clock, which displays the current United States gross national debt and each American family’s share, hangs on a wall next to an office for the Internal Revenue Service near Times Square in New York, May 16, 2011. REUTERS/Chip East