Is Tax Reform Doomed? A Debate.

Josh Barro is the lead writer for the Ticker, Bloomberg View's blog on economics, finance and politics. His primary areas of interest include tax and fiscal policy, state and local government, and planning and land use.
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Last month, Sean West of the Eurasia Group wrote for the Ticker that the prospects for tax reform were dim. Democratic Senator Max Baucus and Republican Representative Dave Camp, who head the relevant tax committees in Congress, had just agreed to pursue tax reform through an open committee process, which West took as a sign that they planned to slow-walk it to death.

Baucus, it seemed, was going to face a tough re-election fight in 2014 and wouldn't want to make the enemies that would come from enacting tax reform. He'd pay lip service to reform but not really try to pass it. It also wasn't clear how committed the president was to reform.

Now, Baucus has announced his retirement, which will give him more freedom. And debt ceiling dynamics have evolved in a way that may force President Barack Obama to push hard for reform. As a result, West thinks the odds of tax reform in the current Congress have risen to 50-50. Josh Barro still thinks it's doomed. Yesterday, they debated the prospects. You be the judge.

Josh Barro: There are three main reasons tax reform won't get done this Congress. First, it's not essential. The only things that make this Congress function are economic and political imperatives -- debt limits have to be raised, the expiration of all the George W. Bush tax cuts had to be prevented. But both parties can go into the next election with no tax reform deal done.

Second, there's not as much bipartisan agreement about tax reform as there appears to be. The main thing Republicans want from reform is a big, across-the-board cut in tax rates, and at least a preservation of current tax preferences for capital. But as we saw with Mitt Romney's tax plan, when you make up for those rate cuts by broadening the tax base, you end up cutting taxes on the rich and raising them on the middle class. That's politically impossible and unacceptable to Democrats. You can only fix this problem by cutting tax rates a lot less at the top, which will make Republicans less eager for tax reform. Plus, Democrats want tax reform to raise revenue, and Republicans want it to be revenue-neutral.

Third, as tax reform gets specific, it will draw a lot of opponents. Both parties say they want "a broader base and a lower rate." But every preference in the tax code has a lobby behind it. Reform will require politicians in both parties to anger various special interests. Since the urge for tax reform is already weakened by problems one and two, such opposition is sure to be fatal.

Why am I wrong? What's the viable path to tax reform?

Sean West: I agree with you that tax reform is difficult, but it's not as difficult as it looked a month ago.

Baucus, heading into retirement, and Camp, who will be term-limited out of his Ways and Means Committee chairmanship next year, face a now-or-never moment. If they want tax reform as their legacy, they have to get it passed now.

Second, Obama may soon be baited into supporting a comprehensive overhaul. The debt ceiling looms near the end of the year, and House Republicans intend to extract something from him for raising it. They may initially demand spending cuts or entitlement reform, but Obama is unlikely to give them much on those fronts.

Watch for the GOP to demand a fast-track tax reform process as a condition for a short-term debt ceiling increase, with the promise of a larger increase if the process is completed. By the time we approach the debt limit in the fall, the tax-writing committees should be ready to move tax reform, and Obama and Democrats will see an easy way out of a debt ceiling fight.

Once the tax reform process is in place, compromising on a final bill won't be as hard as you think. Obama has said he wants $600 billion in new revenue over 10 years if tax reform is tied to entitlement cuts. But once tax reform becomes a stand-alone effort that doesn't involve cutting spending, Democrats won't need to demand nearly so much. That will make it easier to bridge the gap with Republicans who don't want to raise taxes at all.

Under any set of circumstances, it's hard to bet on tax reform completion. But a set of unique conditions give this Congress the best prospects in a generation.

Barro: I agree with you that Republicans are likely to demand, and get, a tax reform "process" tied to the debt ceiling increase. We saw a similar dynamic with the last debt ceiling increase -- the Republicans tied it to the "No Budget, No Pay" rule that forced each house of Congress pass a budget. But that rule did not force the two houses to actually agree on a single budget that gets enacted into law. Similarly, the tax reform process will break down when the two houses are unable to merge their proposals together into a compromise plan.

President Obama has been very clear that he's unwilling to do a tax reform plan that does not raise revenue. Even outside the context of entitlement reform, Democrats are wary of passing a revenue-neutral tax reform plan that would be seen as locking in revenue levels that they consider insufficient. Baucus probably is willing to accept significantly less revenue than Obama wants, but any deal that comes out of the Senate will have to be at least modestly revenue-positive.

Such a plan would not play well with the House Republican caucus, many of whose members have ideological and political objections to voting for any tax increase. The only way to get such a plan through the House would be with a combination of Republican and Democratic votes, and conservatives will feel that Boehner sold them out if the plan passes that way. Unlike with debt ceiling increases and immigration, there aren't strong outside forces that will lead Boehner to take on his caucus and push a deal through anyway.

A tax reform plan without tax increases can't pass the Senate, and one with tax increases can't pass the House -- and therefore none can pass.

West: If we agree that the next debt ceiling increase may fast-track tax reform and that both chambers can pass their own reform plans, then we agree there is a good chance tax reform gets a big boost in the next six to 12 months. The question is whether enough momentum is created to get the two sides to resolve long-standing issues.

It's not a huge leap to bet that the House can pass revenue-neutral tax reform in the next year. If Baucus can produce a reform with a modest revenue increase (say $200 billion over 10 years) that drops statutory tax rates across the board and gives Democrats a way out of another debt ceiling fight as they gear up for midterms, I'd bet that can pass the Senate. The question then is if those two bills can be conferenced. I think they can.

At that stage, Obama will be tantalizingly close to a major growth-enabling legacy item and a free pass out of the debt ceiling, so he will push his party to cut a workable deal. Democrats will get to avoid another debt ceiling vote before the midterms and will muddy the Republican message that Democrats are for higher taxes. House Republicans will be able to claim that they dropped tax rates for all Americans and businesses, which is a key part of the economic vision outlined in the House budget. Everyone will be able to say that they got a win out of it.

Barro: I agree with this analysis except as it regards the House. Conservative pressure groups will go ballistic about a deal that combines revenue-raising tax reform with a big debt ceiling increase. Far from being a "trade," that will look to Grover Norquist and the Club for Growth like two terrible tastes that taste terrible together. These groups want to use the debt ceiling as a bargaining chip to bring spending down; they don't want to give it away in exchange for a tax increase.

Individual House Republicans will come under intense pressure to oppose the deal. And what's their incentive to back it? Whatever deal comes through the sausage factory won't be a "massive growth-enabling legacy item"; it will be a modest simplification with modest economic impacts and modest support from some business interests and opposition from others. There won't be pressure to say "yes" that offsets the pressure to say "no." So I think we will go through most of the process you describe, and then the bill will die in the House, and we'll have had a lot of talk about tax reform but no deal.

West: House Republicans have made tax reform H.R. 1 -- their top legislative priority. And successful passage would allow them to say that they fought back against Obama's big tax increases and delivered lower tax rates and a simpler tax code for voters and businesses, regardless of the Congressional Budget Office score.

They will argue that Obama won't fix the spending problem, so they pushed forward on the issue they could fix, which is the complicated and distortionary tax system and its high rates. They will focus their messaging on lowering rates and compliance costs for the average voter while also providing incentives for business investment and boosting economic growth, which advances their overriding goal of shrinking the size of the public debt relative to the economy.

There are plenty of points along the way where tax reform might fail. But I would be stunned if we get to the point where House Republicans have successfully pushed it to the top of Washington's agenda, all the technical work is done, the president is a champion and both chambers have passed bills, only to have House Republicans walk away because of a small-scale static revenue increase that they can easily write off as necessary to secure the first tax rewrite in nearly three decades.

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