Tax Reform Is in the Eye of the Beholder

In an increasingly polarized Congress, most lawmakers agree that the U.S. Tax Code is unfair, complicated, and inefficient. Yet as President Barack Obama and his economic team consider making tax reform a centerpiece of the State of the Union address this month, they keep bumping up against a simple question: Is it worth it?

The White House is mulling a plan to revamp the code, starting with corporate taxes, Treasury Secretary Timothy Geithner said on Jan. 12. "We're examining whether we can find the political support for a comprehensive tax reform," Geithner said. The Obama team's one condition is that any overhaul must either raise revenue to cut the $1.3 trillion budget deficit or be "revenue neutral," meaning some corporate taxes may rise or fall as long as the levy produces the same amount it does now.

Congressional Republicans say they are eager to work with Obama, and most agree with Democrats that lowering tax rates would involve painful choices to offset lost revenue, including curbs on cherished tax breaks such as the deduction for interest on home mortgages or subsidies for corporations' overseas investments. Within the White House, a vigorous debate is under way over whether picking those fights would be worth the political pain if the deficit isn't also slashed, says a top Administration official who insisted on anonymity to discuss an internal debate.

Republicans say reforms must lower taxes for all—and include both individuals and companies. "Our problem is not a lack of revenue, so I don't want to see tax reform that ends up raising people's taxes," says Senator Jon Kyl (R-Ariz.), the minority whip. Alice M. Rivlin, who served on the deficit reduction commission that in December urged a wholesale rewrite of the code, disagrees. "We need to find a way of raising more revenue, but with a more efficient and more growth-friendly tax system," says Rivlin, who was President Bill Clinton's budget director.

On Dec. 16, Obama met with 20 executives, including the chief executive officers of Google (GOOG) and Cisco Systems (CSCO), to discuss ways to fuel the economy, including tax reform. Dorothy Coleman, vice-president for tax and domestic economic policy at the National Association of Manufacturers (NAM), says her group has recently spoken with Administration officials about a broad overhaul. Geithner was scheduled to meet with chief financial officers on Jan. 14 to continue the discussion, a Treasury spokeswoman said.

One question is whether corporate and individual tax rewrites can be accomplished in tandem. Representative Dave Camp (R-Mich.), the new chairman of the tax-writing House Ways and Means Committee, says he wants to tackle both together. The Administration says only the corporate code is up for discussion now. Coleman says that approach would not satisfy NAM, many of whose companies are structured as S corporations, in which owners pay taxes on company profits at the individual rate rather than the corporate rate.

Administration officials agree sweeping reform is a long shot. The most apt comparison may be the 1985-86 overhaul that dramatically lowered individual rates while subjecting more income to taxation by curbing special breaks. In 1985 there was a Republican President and Senate and a Democratic-controlled House. A coalition of Democratic tax reformers and supply-side conservatives who wanted lower rates joined together to take on the special interests. Still, it took a politically painful year and a half before a measure was enacted. There is little sign of such an alliance today.

The bottom line: Administration officials are debating whether to reform the Tax Code. If they start with corporate taxes only, they'll face GOP resistance.

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