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From Bush, Tax Changes without Reform

By Howard Gleckman Folks have been talking plenty in recent weeks about whether President Bush's extremely ambitious tax-cut package is a step toward fundamental tax reform. It's a step toward something, but it isn't tax reform -- not by a long shot. Think of it this way: Say you're headed from Washington, D.C., to New York City and you stop in Wilmington, Del. You know you're headed in the right direction. But let's face, you haven't exactly made it to the Big Apple.

That's pretty much where Bush is with his tax plan. By proposing to end individual taxes on corporate profits and let nearly all Americans shift their investment income into tax-free savings accounts, Bush would move the country in the direction of a consumption-based tax. But he has stopped in a very different place.

In fact, as it stands, the President's plan is little more than a wage tax. If it were to pass as proposed, about the only income Washington would ever tax would be what arrives in your weekly paycheck. Everything else -- dividends, capital gains, and savings plans -- would be tax-free. And if the tax base is limited to just wages, tax rates would have to be pretty stiff to support government in the style to which it has become accustomed.

CLEARER PAYOFF. Of course, Uncle Sam could fix that problem by slashing spending. But in a few years, 80% of government expenses will go to Social Security, health care, national defense, and interest on the debt. Got any ideas on which of those you'd cut?

Bush might have proposed full-blown reform. In fact, some of his key aides actually liked the idea a lot. And many outside experts say if he had, the economic payoff to his growth plan would have been a lot more clear. But to do mega-reform, Bush would not only have had to do the easy work of cutting taxes on savings and investment but he would also have had to raise taxes on individual and corporate consumption. That would have created some big losers -- and a political firestorm.

Indeed, the Bush tax package quietly adds to those consumption-based loopholes. The biggest: a massive, but completely unnoticed $98 billion tax credit for buying health insurance. Whatever the merits of such an idea, it's hardly reform. Indeed, on the road from Washington to New York, that idea leaves you somewhere in Richmond.

HIT THE JACKPOT. To understand what's going on, it may help to think about what fundamental tax reform is. There's actually a lot of disagreement about that, but most economists say it has three major, related elements. The first is that it lowers tax rates but closes tax loopholes. The second is that it taxes all economic activity once, but only once (today, some income is not taxed at all, while the IRS hits other income two or three times). The last is that a new code ends the current bias in favor of consumption. To put it another way, reform would tax spending more and savings less.

Eliminating many of the tax preferences that have infected the law can often be a three-fer. For instance, many loopholes are intended to encourage spending -- on health care, environmentally friendly energy, education, and so on. They also make it possible to create tax-free income. And, of course, because they drain revenue from the Treasury, they force up tax rates. Get rid of the junk, and you've hit the reform jackpot. But you've also made a lot of special and powerful interests really mad.

A decade ago, the intellectual godfather of the Bush tax plan -- White House economic adviser Glenn Hubbard -- wrote an early version of the scheme the Administration now embraces. In a report released in the last days of George H. W. Bush's Administration, Hubbard laid out his plan to end individual taxes on both dividends and capital gains earned on corporate retained earnings. But that plan was different from the new one in a critical way.

TOWARD REAL REFORM. In 1992, Hubbard urged that the cost of any cuts in dividend taxes be offset by, for instance, trimming other tax preferences. The new Bush plan, of course, doesn't do that. Instead, it turns the dividend plan into a $364 billion tax cut.

Hubbard, who's leaving the Administration to return to academia, is a brilliant economist. And he may figure that, sooner or later, such a wage-based tax system will be unsustainable. And when it is, revenue-starved policymakers will have to reflect more seriously on how to turn the Bush plan into real reform by cleaning up all those consumption incentives in the code. But until some future President does, this tax reform won't be ready to open on Broadway -- or Main Street. Gleckman is a senior correspondent in BusinessWeek's Washington bureau. Follow his views every Tuesday in Washington

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