Rewriting U.S. Law Has Consensus While Fix Proves Elusive

The bipartisan Washington consensus to rewrite the U.S. tax code has a flaw that will make it difficult to turn talk into law. There’s little agreement on what a tax overhaul means and what it’s supposed to achieve.

Republicans, who control the U.S. House, want lower tax rates and fewer breaks in a simpler system that raises no additional revenue. The Obama administration and many Democrats endorse some of those goals -- particularly corporate rate reduction -- while viewing a tax rewrite as a way to guarantee more revenue from top earners.

That split will challenge lawmakers as they decide whether to rewrite the code as part of budget talks or work on a major tax bill without a fiscal agreement. Compromise remains elusive, though the code is more convoluted -- and therefore, ripe for change -- following passage of a law Jan. 1 that raised marginal rates and reinstated limits on personal exemptions and deductions.

“They’ve mucked up the code, and so the more you muck it up, the easier it is to reform it,” said Martin Sullivan, chief economist at Tax Analysts in Falls Church, Virginia. “Unfortunately, we’re in for another partisan battle about whether there should be tax increases.”

Alternative Strategies

The differing goals mean the parties will pursue alternative strategies as Congress begins addressing fiscal deadlines on debt and spending over the next two months.

The administration wants a deal that would use a revenue-raising tax rewrite as its price for accepting spending cuts. They want to lock in revenue now and figure out the details of changes later.

Republicans will resist that fight, insisting on a spending-only approach to deficit reduction while pursuing tax changes for their own sake. They will start in the House and try to build momentum, with or without President Barack Obama’s cooperation.

Either path could lead to passage of a tax-code overhaul in the next two years. Still, given the difficulties that have prevented a tax rewrite for 26 years, either path could collapse.

For the past two years, the bipartisan talks about tax changes have centered on creating a framework as part of a budgetary grand bargain. Instead, Congress and Obama have cut spending and raised taxes in separate laws, yielding no framework, no bargain and no agreement on whether taxes should go up again.

‘That’s Over’

“Back when we had the supercommittee, there was open discussion of using tax reform to actually give him some additional revenue,” Senate Minority Leader Mitch McConnell, a Kentucky Republican, said of Obama in a Jan. 9 interview. “Well, that’s over. He got the revenue by the operation of law, and now I don’t think there’s going to be anybody in our party who’s going to vote to raise taxes.”

The New Year’s Day deal pushed the tax code in Democrats’ direction by letting some of the tax cuts enacted in 2001 and 2003 expire. The top rate on ordinary income is 39.6 percent, up from 35 percent in 2012, and top earners will pay more on capital gains and dividends.

Even as the law sparked partisan squabbling, the result actually narrowed the divide between the parties. Higher rates now make it difficult if not impossible for Republicans to reach their goal of a 25 percent top rate for individuals, meaning that the two parties aren’t as far apart as they had been.

Rate Increases

Obama had to relent and allow tax rate increases to start at $450,000 in annual income for married couples instead of $250,000, resolving an issue at the center of fiscal fights since 2007.

Obama was able to secure about 40 percent of the $1.6 trillion in additional revenue he wanted. That means the parties are now $1 trillion apart instead of $1.6 trillion. Obama’s decision to relent on estate taxes, dividends and the $250,000 a year threshold makes the gap closer to $700 billion, because he probably won’t try to resurrect already-rejected policies.

Republicans, contending that the time for tax increases is over, want tax changes so they can reduce marginal rates and establish a platform for economic growth.

“We pulled a gun away from Congress’s head on expiring provisions, but we haven’t done anything on the business side to improve the climate for investment in this country,” said Pamela Olson, a deputy tax leader at PricewaterhouseCoopers LLP in Washington and the top tax policy official at the Treasury Department under President George W. Bush.

Most Plausible

That’s where Representative Dave Camp steps in with the most plausible path to an overhaul that doesn’t start with a budget deal. Camp, a Michigan Republican and chairman of the House Ways and Means Committee, plans to advance his own bill this year, with or without a bipartisan framework to guide him.

“If the committee and the House act on such a large and critical economic policy, it will be difficult, if not impossible, for the rest of Washington to ignore it,” said Sage Eastman, a spokesman for Camp.

Camp has some company. Corporations received little benefit and suffered little pain from the New Year’s Day tax law, and they remain eager to overhaul the code. So are House Speaker John Boehner of Ohio and Senator Max Baucus, the Montana Democrat who is chairman of the Senate Finance Committee.

Budget Framework

By moving forward with or without a budget framework, Camp’s approach sidesteps an up-front agreement on how much money should be raised. It forecloses that issue for now while giving the Democratic-controlled Senate and Obama a chance at the end of the legislative process.

The administration, on the other hand, isn’t expected to show much interest in a tax rewrite that doesn’t guarantee revenue in exchange for further spending cuts, said David Kamin, a law professor at New York University who helped coordinate White House tax policy during Obama’s first term.

“My sense is they could certainly be supportive of it, but it’s not the leading issue for this administration,” he said.

Obama’s approach, as outlined in an offer to Boehner last year, would implement the president’s proposal to cap top earners’ tax breaks with a delayed start date, giving Congress time to find the same amount of revenue with different policies.

‘Tax Reform’

The two parties can’t agree on what they want from a revamped tax code or what they mean when they say “tax reform,” said Caroline Harris, chief tax policy counsel at the U.S. Chamber of Commerce. Any Republican definition would include lower marginal income tax rates.

“Do we really think the president is going to sign something that lowers the rates on those people?” she said.

Even without an up-front agreement on a revenue target, Baucus plans to work with Finance Committee members on a bipartisan proposal, said a Baucus aide who isn’t authorized to speak on the record and requested anonymity. Much of the potential work on simplification, tax administration and reshaping the code could be accomplished before a deal on revenue, the aide said. The committee staff has been preparing options for senators.

“I’m committed to working together with Dave Camp to close loopholes and simplify our tax code for families and businesses,” Baucus said in a statement. “Tax reform can help simplify and streamline the code while making our country more competitive, boosting the economy, and creating jobs.”

Republican Votes

Without a framework and thus presumably without much support from Democrats, Camp will have to find more votes from Republicans, who control 233 seats in the 435-member House.

That could mean tough votes on limiting tax breaks such as the mortgage interest deduction without a guarantee that it will become law or receive political cover from Democrats, Kamin said.

“People will see their political lives flash before their eyes,” he said.

Obama, who has talked generally about a simpler tax code, has also said he wants to move beyond fiscal battles to focus on immigration policy and tightening gun regulations in his second term.

To get interested in a base-broadening, rate-lowering tax overhaul, Sullivan said, Obama will need a push.

Before it's here, it's on the Bloomberg Terminal.