Setting the Stage for Tax Reform--A Tax Policy Center Forum

The Tax Policy Center

LEN BURMAN: I'd like to thank all of the participants this morning who braved the cold weather to talk about tax reform rather than the NFL playoffs. I particularly thank John Maggs, who at the last minute agreed to stand in for Julie Kosterlitz to be the moderator for this program. John is a distinguished writer for the National Journal. I'm going to pass it off to him to make the rest of the introductions.

JOHN MAGGS: Well, good morning, everybody. Thanks again for coming. A well-balanced panel, I think — we've got Pam Olson, former assistant secretary for Tax over at Treasury; now in private practice. Gene Steuerle, whom I think everybody in the tax field must know as Wiseman Grayhead, I guess they call him. (Laughter.)

EUGENE STEUERLE: Oh, is that right?

MR. MAGGS: And the guy — well? And then a guy with a gray head down at the end: Bill Gale from Brookings, also quite a fixture in Washington. And I think that the format here is that everybody's going to speak for just a few minutes, throw out some ideas, and then we will interact with each other and take questions from you all and that will be the majority of the time here. So, anybody have any — Pam, do you mind going first? Would that be okay?

PAMELA OLSON: Do I mind? No, I don't mind.

Well, it's an honor for me to be sitting here with Gene Steuerle and Bill Gale, two people who really have thought an extraordinary amount about tax reform. I did not come to Washington to work on tax reform and I didn't go to the Treasury department to work on tax reform either. I spent much of my time at the Treasury department trying to figure out how we could simplify and improve the current system, which seemed to me mostly likely to be the system that we would be living with for an extended period of time. Now the topic of tax reform is again on the agenda and I think for good reason.

To my mind, former — the late Treasury Secretary, William Simon, summed it up pretty well when he said, "the United States should have a tax system, which looks like someone designed it on purpose." He made that statement more than a couple of decades ago and it has not improved as the years have passed. Certainly, we have had some changes to the code that many think have improved it, but somehow those changes to the code seem to have been fairly temporary, and we have reverted again to things that perhaps distract from the direction we ought to be going. I think it's helpful to start by thinking about what the goal is of the tax system and that is to raise the revenues necessary to fund the operations of the federal government — that is the basic goal of the tax system. And I think if we look at it, what we would find is, regardless of one's views, that there are some principles that are common that should guide us as we try to design or think about redesigning the tax system.

I always put at the top of the list that the tax system should be simple, and the reason I put that at the top of the list is because I think it drives a whole lot of other things that are important to the tax system. I think the tax system should be transparent. The OECD talks about transparency in a tax system, and if you look at what they talk about, it's really opposite of the Italian system. You know, the Italian system is the notion that your tax burden is what do you want to pay?

And so what we want is a system that people understand that people can evaluate and know what their tax liability is going to be on account of earning money, engaging in a transaction, doing business. That is also important because it underlies confidence in the system. If people think that you can write a check for whatever amount you choose as your tax liability, they tend to think that the system is unfair. And fairness is another element that flows, I think, from simplicity. The lack of simplicity or the complexity of the system leads many people to believe that there are, lurking in the code, provisions that apply to other similarly-situated people, just not them, or that they need to go out and hire a tax-return preparer to advise them because it's the only way they're going to be able to find those things and that, I think, undermines people's confidence in the system, people's sense that that tax system is fair. Clearly, a complex system increases the cost of people complying with the tax code.

It also increases the costs of the IRS administering the tax code. The IRS did a study a couple of years ago on what compliance costs were for individuals and came up with a number of between high 60s to low 90s of billions of dollars on an annual basis. The difference in numbers depends on the dollar figure that you hang on people's time. But complying with our current complicated system is a very expensive task. It also undermines, on the compliance front, the IRS' ability to assure that the system is applied on a consistent basis. The system has just become too complex for the IRS to be able to fairly administer it.

It has also led to the proliferation of tax shelters. Over the course of, in particular, the last 10 or 15 years, the complexity of the code has gotten to the point where people could sell all sorts of things to taxpayers, many of whom should have been suspecting but chose not to be, and some of whom were genuinely unsuspecting. But all sorts of nonsense has occurred because of the complexity of the code. Even for people acting in good faith, you can often time fall into problems because of the complexity of the code and uncertainty about what the right answer is.

The second principle I would say should drive the system is a sense that the system is fair and that means that similar taxpayers should be treated alike, and it means that the system should be progressive, that we should be collecting the money to run the government on the basis of people's ability to pay.

Third principle — efficiency. And this is efficiency that economists know a whole lot more about than tax lawyers such as I. But the system should be neutral. We should not use the tax system to pick winners and losers. Unfortunately, we had a good example of a non-neutral provision added to the code just this past year with the special deduction for manufacturing income, which tilts the system, makes it non-neutral, will over time have some effect on distorting people's investment decisions, and distortions of investment decisions mean that we have a net reduction in national income, and that's not the right way to run the tax system I would suggest.

The tax system should be efficient so that it is conducive to economic growth. We clearly need to keep one eye on what's going on in the rest of the world because there is a lot of competition for location of headquarters, for location of research and development facilities, for location of manufacturing facilities on a global basis now. We want to make sure that our tax system does not impose burdens so as to make it uncompetitive for businesses to decide to operate in the U.S. versus other countries. And the final point on efficiency is low administrative costs. The more money that we spend complying with the tax system, the less money we have available for other more, perhaps, useful purposes.

Fourth principle — I'd say that the tax system should be stable. Right now, we have a tax code that has provisions that look like they are on yo-yos. They go in and out over time and that is, I would say, no way to run a system. Now that doesn't mean that we have to take a system and set it in concrete forever, but clearly we've got to move to a system that does not look like our current system does.

Fiscally sound — the fifth point, fiscally sound. The tax system should raise revenues adequate to fund the needs of government. The economist mantra, I think, is always that we want a broader base and lower rates, broader base and lower rates is the way to move to a system that has a less distortive effect on people's decisions about working, saving, and investing. And I think everything that I looked at while I was at the Treasury department certainly suggested that that was right, and I think that's also consistent with my experiences in the private sector and advising clients. The more that we can do to make the rules alike, the better off we will be.

There are probably just two basic kinds of tax systems — one would be a consumption tax, the other would be an income tax. The virtue of a consumption tax versus an income tax is that the pure income tax clearly favors spending over saving. If we look at two — on the family basis — look at two identical families — same income, same number of children — the difference being that one family spends everything that it earns and the other saves over time, over time what we'll see is an increased share of the tax burden shifting to the family that is doing something virtuous, in saving some of it's income. And that's a strange way for the system to operate. The government, it seems to me, shouldn't care whether I spend my income today or whether I set some of my income aside to spend on a future day in terms of deciding how much my tax burden should be.

The classic income tax system that we have here in this country, with a double layer of tax at the corporate level and the individual level on top of that, particularly favors spending over saving. We also have — with respect to the income tax, another disadvantage of it is the inherent complexity of computing income. On the consumption tax side, you hear about three different kinds of consumption taxes — one being the national retail sales tax. My personal view is that the national retail sales tax — adherents are reflecting the frustration that a lot of people feel with the complexity of the current tax system. However, I think that examined closely, it's not possible to implement a national retail sales tax. The administrative issues with it make it simply feasible. In addition, I don't think that anyone would tolerate the regressive nature of a retail sale tax and so you'd have to build into the system some means of rebating, for lower and moderate income folks, some of the burden imposed by a national retail sales tax. And as you begin that, you begin to move back towards the complexity of the current system.

A value-added tax is really just a more sophisticated way of collecting a national retail sales tax — it collects it along the way, at each step in the process, as opposed to leaving it all for the end — that makes it more administrable, to my mind, but it still has some of the defects of the national retail sales tax. And then, the third kind of consumption tax is a flat tax, which non-economists at least often think of as in income tax — but it's called a flat tax because the base — called a consumption tax because the flat tax base is very similar to a consumption tax base, such as a VAT. My guess is that we end up, when all is said and done, of keeping the current income-tax system, but there are lots of things we should do to look at fixing the income tax.

Right now, a lot of the complexity of the income tax comes from the fact that we administer a whole lot of social welfare programs through the tax code. I would argue that there are a lot of reasons that the tax system is not the best way for us to administer those social welfare programs. Among them are the fact that the tax system functions on the basis of an annual accounting period, whereas people's needs for social welfare assistance tend not to necessarily run with the calendar year. Administering these kinds of social welfare programs through the tax code makes the tax code very complex, but the administration itself becomes very complex, so much so that the people who need the benefits are often unable to find their way through those provisions in order to take advantage of the benefits intended for them. We also have an issue of the fact that when we administer it through the tax code, we measure progressivity or the availability of the benefits via annual income versus assets, and that may not be the best way to judge the need for the subsidy that the tax code is handing out. There are also, I think, though, issues related to the disincentives of all of the means testing that we have built into the tax code and into our social welfare systems in general.

Also, in terms of fixing the income tax, there are lots of issues related to the calculation of business income; particularly, we hear about in the context of corporate taxpayers and large corporate taxpayers, of whom there have been many studies in recent years. And one way, one thing that we might think about to fix the income tax is to look at something like book tax conformity, to my mind has some advantages because it takes Congress out of the business of determining what income is and puts it squarely within the confines of people whose job it is to spend their lives figuring out the best way of calculating income.

Now obviously, we've had some issues with calculating book income in the last few years, but some of those issues have arisen because of the differences between book and tax. And so I think that looking at book tax conformity might be a way to address some of those issues. And with that, I will conclude.

MR. MAGGS: Thank you, Pam. Gene, do you want to —

DR. STEUERLE: Well, thanks, I too am very honored to be on this panel. John Maggs, as many of you know, covers tax as part of the National Journal, which is probably my favorite or one of my favorite magazines. I read very few others anymore these days. I guess that proves how much of a wonk I've really become.

MR. MAGGS: You've confirmed your position as a hopelessly boring person. (Laughter.)

DR. STEUERLE:DR. STEUERLE: And Pam — I've not only known Pam, you know, in her recent role as assistant secretary, but I've known her long before that on the American Tax Policy Institute, whose board we served on. And it was always an honor to work with someone so smart and always had such good things to say. And Bill, of course, is my esteemed colleague as a co-director of the Tax Policy Center, so as I say I'm very honored to work with all three of these people and have over time.

You know, when it comes to claims by politicians that true reform is about to unfold, I'm reminded a bit of the story of this parrot who had such brilliant linguistic talent that his owner took him to the synagogue. And there the owner bet the other members that the parrot could do even better than the cantor for the High Holy Day service at Rosh Hashanah. Well, once the service began, the parrot never opened his beak. Well, later after they got home and the owner was about to mutilate the parrot, the parrot saves himself by suddenly exclaiming, "Schmuck, just think of the odds we'll get on Yom Kippur."

Well, bold plans to set a domestic agenda often target the income tax, which has been saddled with so many tax breaks and preferences that no one, not even the members of Congress, or even the tax-writing committees, know what type of monster they've created. Politicians often delude themselves that reform can occur by proclamation. Yet only painstaking, bottom-up planning can do the trick since the tax system permeates nearly every major corner of public policy in American life. The tax breaks for homeownership provide more subsidies than is provided by the Department of Housing and Urban Development, the Earned Income Credit is now larger than any welfare program such as food stamps, the tax break for employee-provided health insurance is the largest federal health subsidy for the non-elderly, there are more than half a dozen tax breaks for higher education, there are multiple capital gains tax breaks, and so on. Meanwhile, the average citizen faces an array of retirement plan provisions that makes the fabled Clinton health reform plan look simpler than a Starbucks menu. Oops, I mean Starbucks before the latest tax legislation, which sometimes grants a tax break to integrated coffee change, a.k.a. manufacturers, on the value of roasted coffee beans used to brew the coffee.

Well, let's be fair about this. This complexity of the tax system is a bipartisan affair. Both parties are clearly united on a lot of fronts, hiding taxes and tax rates, spending through the tax system, and using taxes to fight every economic and social woe. Social conservatives are no less vigorous than social liberals at pursuing their objectives through the tax code. And recent presidents have all turned to the tax code to get what they couldn't get any other way, whether it be financing of school construction or paying more to the troops.

Now there are two parts to this complexity that are often missed out in the public debate. One is that there are so many subsidies now hidden in the tax code. When President Clinton proposed paying for local school construction — not usually thought of as a federal role to begin with — but when he proposed doing this through the tax system, he wasn't claiming that this was the best way to get the goal accomplished. He felt that he could get this tax subsidy — he could get this subsidy with the tax system, if it was a tax break, rather than an increase in expenditures.

While some also recognized that many indirect expenditures are in the tax system, fewer recognized that there is a parallel in the expenditure system and that is very high marginal tax rates. Our work at the Urban Institute shows that most moderate- to middle-income taxpayers pay marginal rates in excess of 50% and often 100% once you take into account that on the basis of income they are phased out of the Earned Income Credit, food stamps, Medicaid, housing, Temporary Assistance for Needy Families, Pell Grants, HOPE scholarships, you name it. And by the way, these phase-outs are all on the basis of income, which we might discuss later. It has an impact on whether you want to convert to a consumption tax when you have all these indirect income taxes lying around on the side.

Now by way of a little history, before the 1986 tax reform effort got into full swing, I had the Treasury staff delve into 20 tax categories in the tax code ranging from international and itemized deductions, to employee benefits, to family issues; each of these categories themselves entailing dozens of subsidies, special breaks, and complicated rules. That is essentially, we divided up tax reform into hundreds — if you want to — different small modules.

Now, since 1986, the number of such items has expanded every year as the tax reform goals of simplification and broadening the tax base for the succeeding two decades. Now, I know that there are many who are proclaiming that we don't have to deal with all of these issues, that somehow or another, we don't have to deal with these hundreds of provisions in the tax code and that we can just sort of debate only whether we want some broad reform — consumption tax, if you want to, or value-added tax, or retail sales tax, or all the many items that I thought Pamela really covered quite well.

But saying that one is for tax reform is like saying one is for expenditure reform. It's really not a very, informative statement. Throw out the tax code and policy-makers still have to decide what to do about housing, work, education, retirement, charity, energy, environment, transportation, and all these other policies that are sitting there and being implemented through the tax code. Someone still has to decide whether IRS is going to need someone to watch pornographic films because Congress has extended the new manufacturing tax break to the industrial heartland known as Hollywood, excluding, of course, certain "sexually explicit productions," to quote the legislation.

Sometimes reformers can ignore these provisions, but then less is usually reformed. Other times they can't ignore them at all, even if they try. For instance, trying to convert the income tax to a consumption tax could or would remove extra incentives for retirement savings and this at a time when such saving is quite small relative to the needs of a growing population.

However difficult and even quixotic, the quest for tax reform must be undertaken once in a while simply to make the system more workable or else all we get is deform. The trouble is, as both parties admit, to keep today's economy healthy, the public must swallow the bitter pills of tax remedies with a large and equally salty swig of deficit reduction. The president and the Congress have now inherited health and retirement policies, set in motion decades ago that have put entitlement spending and government spending, in general, on an unsustainable track. So exacerbating the fiscal crunch since about 1997, they themselves have gone on a giveaway spree, really unlike anything in the nation's history.

The game in Washington and in most state capitals today is to spend or use up money before the other person does. On the expenditure side, entitlement programs like those for retirement and health are pre-committed to absorb ever-enlarging shares of revenue in an automatic fashion; that is, even in the absence of legislation. Well, not to be out outdone, those who favor lower taxes legislate tax cuts into the future. Guess which programs take it on the chin in this world? Education programs for children, programs for working families, the environment — basically all of the leftovers in this budget process.

Now compared to most of the nation's history, it's only in the contemporary period that deficit reduction, or surplus spending that is not tackling some larger problem at hand, has largely defined policy. If you think about it, the notion that we have to reduce the deficit, the notion that we have to even pare the growth of entitlement spending is not so much a problem of society we're addressing like terrorism or crime, it's a problem in many cases that we've created by the way we've handled our budget. During this modern period, Congress, of course, paid limited attention to the underlying purposes of either tax or expenditure programs, which is quite unfortunate. As I say, think about it — government does not really exist to reduce the deficit, it doesn't really exist to reduce taxes, it doesn't really exist to spend the surplus. It exists to solve problems that we need to unite on at a social level and that we can't solve privately.

Now on the budget front, the bottom line is so much pre-spending and scheduling of tax cuts forces policy makers to renege on their promises, takes democracy away from its citizens, treats future voters as if they are adolescents who need to be controlled, puts the budget on a financial collision course, and ensure that government is designed around yesterday's needs, not today's or tomorrow's.

Well, given all this background, I've come to the conclusion that the tax reform agenda for the near future is not so much the adoption of some idealized tax system, whether it be an income tax or consumption tax, or the removal of tax on capital income, a more progressive weight subsidy system, or any of the other host of reforms that many people want. That is not to say that we don't have to make choices on each of these matters. But in the end, the real reform required is in the processes themselves. Process reform is necessary to deal with two major fiscal problems that have become full-blown by the end of the last century; and that is to say, in the current period, the lack of principled tax policy development and a long-range budgetary quagmire.

Now we can't control lobbyists or special interests nearly so well as we can strengthen those parts of the system that are meant to provide us with some non-partisan analysis by which to proceed. This means that as part of a process of reform, we need to strengthen even further the IRS, the Treasury, the Office of Management and Budget, the Congressional Budget Office, the Joint Committee on Taxation and the General Accounting Office. Right now, these are the agencies that are designed — that are meant to deal with the public on a broad scale. They don't represent special interests or even special fields of government.

Right now, the information they develop, however, is often hidden or, when made public, is simply not allowed to rise to the top of the debate. As for the budget, the Congressional Budget Committee should be empowered to enforce rules that only through future legislation can any program increase costs beyond some initial period, say four years. The grand budget compromise that must take place is between those who would allow retirement and health programs to continue to grow without bound, faster than the economy, and those who would continually prescribe tax cuts into the future. That is not to say that we can't have retirement and health grow. It's not to say we can't have tax cuts into the future. It's the preordination of these events taking place years into the future that's causing so much of the quagmire we're in.

Given all this background, what's the prognosis for a Bush tax reform? Well, infinitely more than the moon and the stars must align to again enact significant changes to such an all-powerful system as taxes, when losers are going to be identified, no one party wants to act alone for fear of political suicide. Sure, the Republicans and Democrats can give away more money to their favorite constituencies, but that's no longer the game at hand. Reform will lower some people's taxes probably, but it will also increase those of others. For true reform, Republicans must align with some Democrats and the administration must align with Congress. At this point, neither the President nor any member of Congress has put forward any tax reform concepts with enough oomph to prompt this realignment. True, there have been some statements about moving towards a consumption tax, about leaving the mortgage interest deduction alone, about taming the alternative minimum tax, and about retaining progressivity.

But think about all of these statements you've heard. Each of them basically identifies who might win or hold ground; it doesn't identify who is going to pay. And reconfiguring taxes according to basic principles is much tougher now than it was in the mid-80s because the long-term deficit is much worse, since the upcoming baby boom retirement is no longer around the corner but right down the street. Indeed, the broader budget battle has becoming the 20,000-pound gorilla around which the other legislative monkeys must play.

Still, just as in the mid-80s, there are grave political consequences to doing nothing to reform taxes. This time around, for instance, the alternative minimum tax is on track to ensnare 29 million households in an expanded paperwork nightmare by 2010. Meanwhile, real tax shelters are enough out of control that they too must be addressed.

I think we can get out of this maze. On the budget front, those who would allow retirement and health programs to continue to grow without bound and those who would dictate tax cuts stretching far into the future have to come to some grand compromise. What may — in fact, will force action is the need to maintain education, jobs, community development, environmental, and other programs — all those programs that are scheduled to disappear if current trends continue.

On the tax front, the new commission should probably give most attention right now to the principle of simplicity. Just look at the complexity programmed into the alternative minimum tax. Now it may be politically hard to sell AMT simplification by itself since it would do little or nothing for all low-income and many middle-income taxpayers. But ignoring the AMT's perverse effects on tens of millions of taxpayers will be harder still and by harder still, I mean politically harder still. For that reason, a wide-reaching reform package may be the only way out for the politicians and the AMT reform could be the horse on which the broader package rides.

I also think that the commission would be wise itself to face up to the issue, right up front, of whether it's going to admit that there are going to be losers in the process. For instance, it could skip over the broader debates on consumption versus income tax and all of these types of issues if — for instance, just look at the six or seven educational tax incentives. Ask itself whether it's willing to try to simplify and reform these six or seven or not. This, by the way, is the way we got tax reform going in the tax effort in 1984 leading to the Tax Reform Act of '86 — is we started off with those items that weren't those grand philosophical differences and we tried to force the secretary to say whether or not he was willing to tackle these types of issues and recognize losers. If the commission is willing to say that it is going to recognize losers on the way to simplification, then it's going to admit to the public the political cost that that's going to entail, and if it doesn't admit it, then it's going to have to turn inward very quickly and ask itself just exactly what it is about.

Let me also be clear about tax rates. Given a revenue target, rates are essentially determined by the size of the tax base. They are determined at the end of the process, in some sense, rather than the beginning. The commission should, I believe, as we did in the 1984 study leading to the Tax Reform Act of 1986, determine the rates as a consequence of, not a prelude to, its determination of the tax base. So it needs to recognize that every time it fails to expand the tax base, it is raising tax rates as a consequence.

Most of all, the commission is going to have to let elected officials know early on that they are going to have to gear their processes to make very different types of choices than have been made lately. The legislative ledger is quickly filling with requirements for both systemic reform and for deficit cutting, and these require identifying who is going to pay the price for civilized society and the cost of reform.

Congress, if you think about it, hasn't been asked to do this for some time now. It hasn't recognized the losers from systemic reform or deficit reduction for many years now. There is opportunity but leadership and some optimism is required. One most avoid the predilection of pessimist, who, as you know, when they smell the scent of flowers, look around for a casket.

Thank you.

MR. MAGGS: Well, I'll be thinking about whether the corpse is tax reform as I listen to Bill Gale. (Laughter.)

WILLIAM GALE: All right, well with that stirring introduction — (laughter) — maybe I should just stop. It's a pleasure to be on this panel, it's always a pleasure to be here at Urban, and it's always a pleasure to talk about tax reform. But I must admit to feeling a little jaded about the topic, as somehow it seems like we've been down this path before.

Pam gave a very nice list of principles of tax reform that I think everyone can agree on: simplicity, equity, efficiency, stability, fiscal soundness. Gene showed that it was even more complicated than that and brought tax reform into the world of budget reform and the long-term fiscal issue.

I'm going to start at the other end of the spectrum, with my feet on the ground, not because that's the only right way to do it, but just to provide a third supplementary approach to these issues.

So despite all this discussion of tax reform, the central tax question facing the country right now is whether to make the tax cuts permanent or not. A cynic might say that one reason the president wants to talk about tax reform — which is a nice-sounding phrase and doesn't sound like there are losers and certainly, everyone is in favor of tax reform — one reason to do that is to avoid having to discuss the glaring tradeoffs and the creation of losers that would occur if we make the tax cuts permanent or if we don't. So for example, if we do make the tax cuts permanent, the loss in revenues would be about two percentage points of GDP. By comparison, that's roughly three to five times the size of the Social Security shortfall over the next 75 years, which the president has declared a crisis. So if Social Security is a crisis, certainly making the tax cuts permanent is an even larger fiscal crisis in the brewing.

A second issue is that to the extent that these revenue losses are covered by reductions in spending, they would likely make most of the population worse off on net. Some work we've done here at the Tax Policy Center suggest that if the spending cuts are proportional to income, three quarters of households would actually be worse off with A) the tax cuts, B) the economic growth that would occur, and C) the spending cuts. So you'd have pretty massive redistribution, even accounting for economic growth.

And it would require very large cuts in spending to pay for the tax cuts. In 2014, if you exempted the big six — Social Security, Medicare, Medicaid, Defense, Homeland Security, and net interest payments — you'd have to cut the rest of the government by half to pay for the tax cuts in that year. So, to the extent that these spending cuts don't occur — and I can't imagine that the Congress that has raised spending dramatically the last three years in all categories and enacted a gigantic Medicare entitlement would cut the rest of the government by half — to the extent that such spending does not occur, the revenue losses have to be financed by borrowing, and studies by the Congressional Budget Office, and by various of academics, and by some think tanks associated with the Tax Policy Center, have shown that that would reduce economic growth, not increase it in the long-term; that is, the long-term cumulative effect of those deficits that would outweigh the beneficial effects of lower tax rates.

So while we talk about tax reform, let's realize that there's this — what Gene referred to as the 20,000 pound gorilla — I think it gained 19,200 pounds — (laughter) — but however big that gorilla is, that gorilla is making the tax cuts permanent and that's the issue right now. And it has a direct effect on tax reform too because the commission is supposed to come up with a revenue-neutral tax reform. Well, revenue-neutral relative to what? Relative to current law, which allows the tax cuts to expire or relative, to the president's budget proposal, which will inevitably include an extension of the tax cuts? I don't know the answer. I don't know what the directive is to the commission, but that distinction is two percentage points of GDP and that's a lot of money in terms of revenue.

The other reason to focus on making the tax cuts permanent as an issue for tax reform is that if you do extend the tax cuts, you make the AMT issue far worse. So you get many, many more people on the AMT if you make the tax cuts permanent than if you don't. And as Gene mentioned, the AMT might be the horse that drives all this stuff, so there's a very distinct connection between making the tax cuts permanent and tax reform.

So let's talk about tax reform. I think everyone agrees on the goals of tax reform — I think Pam laid them out very nicely. We have huge debates about some aspects of taxes like how much revenues the government should raise, who should pay it, how much incentives we need for growth and stuff like that. Those issues will never be resolved because they depend a lot on value judgments, not just technical issues. But take making the tax system simpler.

Every single person who looks at the tax system thinks it should be simpler. I have never heard anyone say, the problem with the tax code is it's not complicated enough. And you never will hear anyone say that. But every single year, the tax code gets more complicated. All right? It's the one thing everyone agrees on and it gets worse every year, which suggests to me that there's a huge gap between tax systems that we can write down on paper and think of as ideal and tax systems that exist in the real world.

So Pam mentioned this great quote from William Simon about the tax system should look like it was designed on purpose. Well, that's right, but we have to remember that every provision in the tax code was designed on purpose. Somebody fell on their sword to get that provision in the tax code. And you may hate it and I may hate it, but to someone else that's the greatest thing and they're out there popping champagne corks that they got this thing in there. So the political constraints on reform are really tight, I think, and to paraphrase Donald Rumsfeld, we have to start reform with the tax system that we have — (laughter) — not the tax system that we wish we had. And so, I think that's a serious constraint.

All right, let me turn briefly to the administration's Tax Reform Commission. It seems likely to me that, given the queasiness about fundamental tax reform and given the short timeframe they've been given, that they're not going to go the fundamental tax reform route. They're much more likely to go with something like increased incentives for saving and investment, which is very consistent with previous administration policy. And there's this thing called five easy pieces, which basically argues that you can get the effect of fundamental tax reform; that is, you can move to a flat-rate consumption tax from a progressive income and wealth tax in five steps. And I think the five steps are: reductions in income tax rates, especially for high-income households; increases in contribution limit for tax-preferred savings accounts; expensing of business investment; repeal the estate tax; and a reduction in dividends and capital gains taxes. Now if that sounds a lot like what the administration's been doing in the last several years, it's probably not an accident. Although the administration never put it in those terms, those features are certainly prominent in recent administration policy.

The problem with these changes is that they don't add up to a well-defined tax system. And the key word there is system. Let me emphasize one aspect of this in particular. You cannot exempt capital income from tax and leave interest deductions in the code and expect to have anything but gigantic sheltering going on, and here's why.

Suppose we create Roth IRAs with no contribution limits, but you do get an interest deduction. Well, if that happens, Gene and I are going to lend each other a million dollars. There's no cash that actually transports, I just give Gene a piece of paper that says, I owe you a million dollars, Gene gives me a piece of paper that says he owes me a million dollars. Every year we pay each other $50,000 or $100,000 in interest — again there's no cash that's trading hands — we don't have to declare the interest as income on our tax forms, but we get to take the interest payment as a deduction. So we each get $50,000 a year deductions or $100,000 a year deductions with no income offsetting it. Now, since there's no income changing hands here, choosing to lend each other a million dollars is really being pikers about it. We could make it ten million, same thing; a hundred million, same thing. There's still no income changing hands — you can generate unlimited interest deductions that offset — not only is your capital income not taxed, but you can then offset your wage income with it.

So what you end up with, if you take this into the extreme, is essentially a wage tax on low-income households who are too dumb to pursue this obvious investment strategy. So you're not going to a consumption tax, you're going beyond a consumption tax to a wage tax, and you're going beyond a wage tax just to a wage tax either on dumb people or low-income people. And so that's a very different system than a consumption tax.

A well-defined consumption tax would treat interest income and interest expense consistently. Now the obvious objection to this extremely over-simplified example I gave is that there are safeguards in the tax code. You can only borrow against your house so much. I think the interest on principal up to a million dollars is deductible. Interest payments that you make to invest are only deductible up to the point of your investment income, stuff like that. I understand all those issues. But we have an incredibly talented sector in this country called tax planners — accountants, lawyers, financial planners — and when there are shelters like this, when there are differences like this in the system, they can be exploited. I don't know exactly how — maybe you take the money offshore, you send it to someone, they send it offshore, they send it back — I don't know. But I guarantee you that if we don't tax capital income and we do give interest deductions, you're going to find sheltering. It may not be obvious but it's a huge loophole, and the tax shelter industry would not be living up to its name if it could not exploit that. There are other issues with what the five easy pieces step does, too, but let me skip that and just turn briefly to some other things.

The other main critique of the whole consumption tax approach is that the benefits are supposed to be making a tax system simpler and stimulating economic growth. I don't think we're going to get a simpler system for most people out of the consumption tax that might emerge from the political process. I can understand you can write down a simple consumption tax on paper. I'm saying the tax that goes through the legislature, that is exposed to lobbyists, that is exposed to public notions of equity and intrusiveness, that is exposed to the tax shelter industry's ability to find loopholes will not end up simple. So the simplicity argument, I think, is overstated.

The other argument is the economic growth argument. That depends crucially on saving being sensitive to the after-tax rate of return. Studies show that the best way to raise national saving is to improve the fiscal status of the government and that tax incentives to raise private savings have not worked very well.

Gene has this amazing statistic that he just published in Tax Notes a couple of weeks ago that shows that the tax expenditures on saving incentives right now are larger than personal saving in the country. If the goal was to raise economic growth — and the only way to do that is to raise national saving — the best way to raise national saving is improve the status of the government and if we want to try to raise private saving, we have a variety of mechanisms that are not fundamentally tax-related, like automatic enrollment, automatic escalation in 401k plans that look like they're far more promising to raise private saving than expanding contribution limits or exempting capital income.

So let me stop there and thank Len and Bob and John for putting together such a nice panel.

MR. MAGGS: Well thanks, Bill. Let's see, I think I just want to throw out a few thoughts from what I've heard the last few minutes. A recurring theme, I think, for what Bill and Gene had to say was the central importance of budget reform in the context of tax reform and whether the crisis — I mean, if I'm not going too far to say — whether we have a crisis in the budget that is really so much greater than the crisis in the current functioning of the tax system that needs to be addressed first, and can we really even be talking about tax reform without talking about budget reform. I think that's very interesting.

Gene, when you told your parrot story, I thought — it made me think that the moral of that story I suppose was that the goals are often not as apparent as we might thin, and I think about that in the context of tax reform because I think, at the outset, we have to ask, what is the real goal here? I mean, I think there's a number of possibilities that people murmur about, even professionals in the field, that kind of boil down to how serious are they.

It seems to me one of the questions to ask is, is the goal just more tax cuts and a certain kind of tax cut? That's certainly a possibility. Another one, considering the problem with AMT that you've sketched out, is — and this gets back to budget problems the administration will be facing in the next couple years — is the goal, ultimately, tax increases of one kind? I mean, are we just looking at a way to make tax increases palatable — to somehow, perhaps in the context of some big budget deal to address this long-term fiscal problem that we've created for ourselves.

There's another possibility, of course, and I hear people murmur about this. Is this administration just talking about tax reform as a kind of political strategy that might be related to ultimately building support among certain parts of the business sector for something that they've been agitating for — or to put it more plainly, it is simply a fundraising ploy? We saw in the first four years of this administration, the administration talking a lot about tort reform and talking a lot about capping punitive damages and making it a big political goal. It was a huge, huge issue for the business sector. The Republicans collected huge amounts of money for it. But you didn't see Bush commit any kind of political capital — to use his term — to that goal, and now things have kind of switched to just talking about medical malpractice.

But one should ask, is this discussion of tax reform just going to be part of a multi-year process, in which those constituents that have a particular axe to grind or goal in that area are just going to be lobbying the government and contributing money and ultimately, all that we'll get at the end of it is just a lot of money raised?

So let me just finish with one question to the members of the panel and that is — something else that I've perceived in the comments of the three experts we have here — and that is, there is a tax commission that's been constituted and the goals that have been set, related to fundamental tax reform, yet those goals and everything that the administration seems to be saying are really at odds with this kind of spreading perception out there that it's not fundamental tax reform that's the real goal here, it's tinkering here or solving this problem or going in this direction or maybe just providing some context for taking another run at making the tax cuts permanent.

So I'll ask the three of you and please chime in as you see fit — is there, in and of itself, a problem when you set out goals that are so broad yet the perception is that those are not the real goals? Can you really — what kind of a process and what kind of a result will you get when there is this cynical perception out there that that is not the goal at all? I don't know, Pam, do you have any opinion on that or —

MS. OLSON: Throwing it to me on the cynical front. Well, first of all, I am not a cynic and I've never been a cynic and I'm actually, for those of you in the audience who know me, a Pollyanna, an endless Pollyanna. So you can discount my remarks on that basis alone. But having spent time in three years in the administration, I can tell you that the president is one of the most principled people that I know. I don't think that he or Vice President Cheney have any particular fondness for K Street or for those who spend money on K Street. And I can also tell you that he is a doer, and he doesn't take things on as academic exercises or as fundraising things for K Street. So I think this is on the president's agenda because it's something that he thinks needs to be done.

I'm not sure that it's something that he eagerly embraced either. There was a lot of skepticism in some of the initial conversations about tax reform and the merits of tax reform. I think he has embraced it over time because he has come to see that it really is a problem, that it really does need to be addressed.

That said, there are a lot of inconsistencies, and one of the things I find frustrating about Washington is the failure to look at things on the system-wide basis that Bill mentioned. But if we think about — the fact is, as Bill mentioned, that we have all these provisions in the code and that somebody fought hard to get these provisions in the code. That is generally true, but there are, I think, few provisions that end up in the code as the people who were pushing them initially intended them. And certainly, there are lots of things that end up in the code — and despite the fact that they've been around forever and one would think they have been very carefully and fully thought-out, that tends not to be the case. We did have one major piece of simplification included in the legislation that was enacted last year, and I thank the Senate Finance Committee staff, one member of whom is here in the audience today, for their tireless work on that, which was the unifying the definition of child. With five different definitions of child in the code — added with somebody thinking at some point, it was the right answer for something or maybe somebody not going back to look at other provisions to see or think about how people could cope with trying to recognize that they had to look at different definitions of child for different purposes — that effort was, in fact, when you go back to the original introduction of the proposal to unify the definition of child, a thirteen-year effort. It started in 1991 and finally got done in 2004, and I'm not sure that it would have gotten done, but for the fact that the Secretary of the Treasury, Paul O'Neill, was grabbed by it when we went through a list with him — a very long list of simplification items — and said, well this is one that's easy to get behind, let's push that. And so, it did become something that the secretary of the Treasury talked about, that others in the administration talked about, it was something that grabbed people, that they could identify with.

Anyway, the process of writing tax legislation is an extremely difficult and complicated one. But I don't think it's right to assume that what ends up in the code is necessarily what we would create if we were going to go back to scratch and undertake the sort of effort that was undertaken in '84, '85, and '86 with a massive reform effort. And that is what I think is needed right now. Now, we may unfortunately end up — because nobody has got the energy to push it across the finish line — with some more tinkering around the edges, but what we really need to look at is some fairly fundamental changes. Bill mentioned the problems with the deducting interest, which is actually been something that if you're reading between the lines in some of the interviews that are showing up in the press lately with Secretary Snow, something that he is focused on — that you don't want to end up with a system where you have negative income tax rates, which is what you would end up with if you don't do something about interest.

The Treasury Department — this is an issue the Treasury Department studied extensively back in the early '90s. There were two studies that were put out — one on just integrating the corporate and individual income tax systems in '92 and then in a later study it was called a comprehensive business income tax. And what it did was to focus on the fact that interest deductions do put major holes in the tax base and if you actually want to move towards a tax base that comprehensively includes all of the income earned in the business sector, then you would address that issue.

But — so what I think we need right now is a broad look at the tax system as a system. We have to go down and we need to look at individual provisions, take them apart, figure out how we can put them together in a more rational fashion than they've been constructed over the years. I'm married to the person who served as the manufacturing czar at the Commerce Department until a real manufacturing czar was appointed, but anyway, we talk about manufacturing at our house a lot. And one of the things that we've talked about is the fact that in the manufacturing process, you have this constant drive towards perfection. You always are moving to try to eliminate defects. And that's how we get to first-quality products and become leaders and so forth in whatever it is we're making. Well, if you look at our tax system, our tax system, is in many places, a lot like a manufacturing process. But we don't have in place anything that tries to remove the defects, the complexities, the frictions, the things that get in the way of the process operating smoothly.

And in some ways — I've heard Gene talk before about the things that we ought to be looking at in the legislative process — and in some ways, what we need to be thinking about in connection with tax reform is the kind of things that we ought to be doing with the legislative process so that it can function to produce a system that works better.

I'll make one last comment on the revenue-neutral plan. What does the president mean when he says revenue-neutral — and in that regard, there was a letter from Chairman Grassley and Senator Baucus to the commission — or advisory panel, I guess it is — advisory panel of chair and vice-chair last week talking about the fact that revenue-neutral — if I'm reading the letter correctly, revenue-neutral to them means revenue-neutral against current law, which wouldn't mean a sunset of the tax cuts, in terms of looking at the revenue baseline, which is certainly something that — it seems to me, if we're going to deal with red ink, we're going to deal with the individual AMT, and we're going to deal with sunsets, we've got to put all of these things on the table and look at them altogether and come up with a reform of the system.

DR. STEUERLE: John, if I could jump and answer your question, too. I want to make reference again back to a little bit of a story of what happened in the '84-'86 reform process, but as I do that, I'm actually reminded of a time I went up to my daughter's school at Swarthmore and was asked to give a talk. And I made this analogy between — actually between the 1981 tax cut and the 1963-64 tax cuts. And I looked out at the audience and the professors were sort of nodding — you know, they understood it — and then the students were just total blank stares. And all of a sudden, I realized, to give an analogy to anybody, people have to understand one part of the analogy or else the analogy doesn't make sense and none of these students knew what the 1981 tax cuts were.

So I go now — the beginning was — as we go back to '84 and '86 stories, they're getting older and older, in terms of examples of what reform means. But you may remember, President Reagan, 1984, made a promise to do a tax-reform study and the response from Congress — and it was literally, they laughed during his State of the Union address when he made it because they were thinking about all the battles they had had over the 1981 legislation — they thought that in terms of the budget, the deficit, it was totally out of hand.

But, like Pam, I think in the end this President —any president, in the end — wants, at some level, to do good. They want to be known for doing good. They may make a lot of political compromises along the way, and they may indeed, like all of us in our personal lives, confuse when our principles and our self-interest become confounded. But I think, in the end, people do want to do good and how can we sort of hold them — push them — in this direction, and sort of push and encourage that side of them.

And, at the time, in the '84, '86 tax reform effort, there were books coming out saying tax reform: the impossible dream. So people were very cynical both about what was the reason for this tax-reform study, and in fact, there were clearly people in that administration who wanted the study because at that time, they wanted to keep it out of the campaign, it was a political reason, it wasn't necessarily an economic or social one — and I'm sure there are people in the administration who feel the same way now. But I'm convinced that any Treasury secretary believes in tax reform, because they sit there in Treasury, they see the problems in IRS, they see the problems in tax policy, and they want it — whether they succeed in getting there, I don't know.

So I think the wish is there, but that gets back to the other part of your question, John, which is, well what is tax reform? And as I've tried to say, in my earlier talk, saying you're for tax reform is like saying you're for expenditure reform, it basically means just a whole mass of — range of possibilities — and in some ways politically, what the administration has done is decided to put that issue off a little bit, because they would like to get on board the tax cuts they want, to basically get the government toward — kind of create some trend — toward smaller government. And while you and I may agree with Bill that budgetarily, you can't get there from here since you can't have these tax cuts and these expenditure rope, there's another side of me that says, well politically, the Republicans are just doing what the Democrats have succeeded in doing. In some sense, the Democrats have got this expenditure rope built far into the future and the Republicans are trying to match it a little bit. They're not actually succeeding because the tax cuts eventually get offset by tax increases. The expenditure increases only get offset by lower expenditure increases. And so, in some ways, we all know it's out of balance, and so they're playing this game of chicken of trying to set a baseline — if you want to — for negotiation, a baseline all of us know don't work — especially, I see a lot of people in this room that do this — when we add up the numbers, we know the numbers don't add up. So that's tough — how do you then get tax reform in the midst of this process where there's this game of chicken going on with the budget, but people recognize we want to simplify and reform the process of tax reform — not tax reform.

And the only add-on I add — because I want to give Bill a chance to jump in here too — is I do sense — and this is more of an empirical statement than a theoretical one — I do sense that politicians are much more likely to be principled, in the way they engage in legislation, when they are forced to identify losers — and by being forced to identify losers, I mean they can't get around this any longer. They have to do AMT reform, they have to do deficit reduction. All of a sudden they have to identify losers. We've been on a street for about seven years where all Congress and the executive branches have done is identified winners. It's either been tax cuts or expenditure increases — or you name it — but it's always been identifying winner. And somewhere or another, that seems to be less principled. It's almost like, if I give you a thousand dollars and give Pam ten dollars, Pam doesn't protest as much, however inequitable that may be. But if I have to tax you a thousand dollars, by gosh, I better start — or cut back some expenditure that you have that's worth a thousand dollars — by gosh, I better have a much more principled reason for it. I'm not saying the world should be that way, but I do have some sense that when times get tough, in some ways, we get more principled about what we do. And so, in that sense, I'm actually hopeful that we may see some good things in the next few years on the budget and the tax front.

DR. GALE: Okay, thanks, I first want to respond to something that Gene said, and then actually address your question, John. Gene said that basically the problem is that Democrats have built in all this spending growth and the Republicans are just responding by building all in these tax cuts. Well, the expenditure growth is basically Social Security and Medicare. Social Security is on a path set by the '83 Commission, which was chaired by Alan Greesnpan, appointed by Ronald Reagan, it was a bipartisan effort, so it's hard to blame that one on the Democrats. The Republicans pushed through the Medicare prescription drug benefit, which costs 17 trillion dollars over the long term, over Democratic objections. So, it's hard to pin that one on the Democrats too. So, I would say that if we're casting blame here on — you know, the spending side right now, a big problem is stuff the Republicans have either signed onto or agreed to over Democratic objections — on the tax side, the overwhelming majority of Congressional Republicans have signed the no new taxes pledge. Eighty-five percent of the signers who signed that pledge also voted in favor of the Medicare drug benefit. The president has signed a no-new-taxes pledge, the president signed the drug benefit. So, if there's a long-term fiscal problem going on here, we're talking — it's been ratcheted up enormously in the last three years by the tax cuts, the no new taxes majority in Congress and the Republican Party, and the prescription drug benefit. So, that's just a factual issue.

DR. STEUERLE: I don't think we're trying to pick parties here, by the way —

DR. GALE: Okay, but you were. But you were.

DR. STEUERLE: There are stereotypes I agree with.

DR. GALE: Okay, let's go back to principles for tax reform. Why are we having tax reform? The short answer is I don't know — but I can say more than that. I can expand on the depths of my ignorance. It is accurate to say that tax cuts are a policy that unifies all the elements, all the fringes, all the groups of the Republican Party. It's got to be a good fundraising thing. I don't know if you remember in October of 2002 Treasury had a big, couple day long event that was closed to the media. A bunch of tax reform advocates coming in and talking about their tax reform plans and stuff like that and the timing, I remember it as being conspicuously right before the election — the midterm election. So, there's definitely a political side.

MS. OLSON: I don't think I was invited.

DR. GALE: Okay — (chuckles) — there's definitely a political angle to it. Now, there could also be a principled reason for it. And I don't dispute Pam at all when she says the president is one of the most principled people she knows. I'm sure that working inside the administration gives you a different view than working outside the administration. Working outside the administration, I'm perfectly willing to believe the president has principles, but I'm just not sure what they are. I'm not sure what economic principles led him to impose tariffs on steel, I'm not sure what budgetary principles encouraged him to relentlessly pursue tax cuts — and not only not to pay for them, but to have it in his budget last year, a proposal that would have made the tax cuts permanent without affecting the baseline. I'm not sure what principle leads the president to say that he's addressed the Medicare problem by enacting a prescription drug benefit that increases the long-term deficit by 17 trillion dollars, and I'm not sure what principle gets the president to say that individual accounts help solve the Social Security problem, when the individual accounts that his commission has proposed in model 2, make the long-term funding problem worse. Okay, so I'm sure the president has principles that drive his motives for tax reform, but I'm not confident that those principles are things like budgets ought to add up or features of the tax system ought to be consistent with each other. So, I share John's concern that — or reading into John's question — I share the concern, the potential concern that the Tax Reform Commission is really a red herring onto which other agendas can be placed. Let me put it that way.

MR. MAGGS: Well, I think we've talked enough, so maybe we'll see if there's some questions out there. In the back?

Q: I'm Catherine Rudder from George Mason University School of Public Policy. Two of the panelists, Pamela Olson and Gene, both mentioned that it was really good to face up to who the losers are. And I would just like to suggest an alternative view and see what you think, and that is, often times, when there are losers, the reverse happens. That is to say, they mobilize and they kill proposals. And if Gene's experience in '84-'86, it wasn't clear exactly who was going to win and lose. The big tradeoff was with business and getting rid of some of those deductions — isn't that correct — and in exchange for that they also — the combination was a tax rate they could live with. And it wasn't all that clear, if anything, they were going to be winners. But we also know from psychological research that people fight much harder to retain things that they have — benefits that they have — than they fight to get new benefits. That's not to say they won't fight for new benefits but — so you have a differential in intensity, put it that way. And also, you have just the public choice problem of spreading out the cost versus the concentrated benefit, which is yet another aspect of this. I wonder what your response to that or Bill Gale's response. It just seems to me that the best way to have tax reform in fact, is not to explicitly identify losers. I just want to put that on the table as a possibility.

DR. STEUERLE: Again, I can only go back to sort of an empirical observation. We had exactly — when I came to Treasury long ago in the mid-'70s — we had the same argument that we could buy reform. And we had — because of inflation mainly - we had a fair amount of surplus and the notion was, well we could always at least appear to identify — by the way, this is all appearance because you and I know that everything government does is a balance sheet, so everything government does somebody pays for, it's just the losers are hidden. So, I mean in terms of talking about losers and winner, it's really all about — there is a net acceptance that government makes things more efficient or better — you know, it adds up to zero. But there was this notion in the '70s, we had all this inflationary bracket increase, we could buy tax reform and basically what we got was tax deform. And it wasn't really until the budget got tight in the '80s and we had to do deficit reduction and the tax system was really out of control on the tax shelter front — it was a different type of tax shelter then, it was really out of control — we had to deal with it — that we really got, I think, some principled tax reforms. It wasn't just '86, it was actually '82, and '84 and some of the deficit-reduction packages.

So just empirically I'm saying, it appears that somehow or another when times are tough, principles seem to matter more and in some sense, when we had money to buy reform, we didn't get it in the '70s, and we had money to really buy the types of simplifications we often talk about. We really didn't get a lot of it, we got a little, but we didn't get a lot of it. Here and in the period form 2000-2004 because the emphasis was on giving the money away and the same thing happened in the late '70s. So, that argues, at least empirically, there is a case to be made for the fact that yes, the losers will mobilize, but when things have to take place, when government has to act, it's going to have to recognize losers and their mobilization will be less.

Now there's a second aspect to what you said, I think, that's more complicated. We've always been good as a nation at either taxing the rich forty ways of Sunday or giving them tax breaks forty ways of Sunday. So we have this huge fight over the rich but it's sort of we can often demagogue or we can get majorities to tax the rich but the rich can often come in, because they also have more money to contribute, and then get things back. And so we have, perhaps one of the worst parts of our tax system is often in terms of taxing the rich, because we both double-tax and triple-tax them sometime, and then don't tax them at all. On another front, it sort of depends on how you try to add all that up. When it comes to the middle class, you're probably right, we've probably been less successful at taking away either expenditures from the middle class or tax breaks for the middle class. We didn't really succeed that far in tax reform in the mid-80s. What's affected the middle class is a lot more of the — if you want to — the programs within the tax system are now middle class. Tax cuts — and to the extent, tax reform means that type of base-broadening — we haven't had a lot of success there. So there, you may be offering a warning that something else is going to have to happen to make it take place, and maybe the system again has gotten so out of hand that even middle class base-broadening may be possible.

DR. GALE: I think your observations about the psychological tendencies are exactly right and I think there are two implications. One is that in order to mollify the losers, you have to have a lot of moving parts at the same time, so people can't tell what's going on. The perfect example of that is the American Job Creation Act from last year. All we had to is repeal ETI, right? We didn't, we ended up with 87,000 provisions because if you just repeal ETI, you would have identified losers and for your reason you mentioned, it doesn't work. The role of individual accounts in Social Security reform is the same thing. That is, all you need to do to fix Social Security is cut benefits and raise taxes, but if you do that, it will be obvious to people what's going, they'll be annoyed. So you create an individual account, you have further benefit adjustments, there's a lot of things moving around. You try to sell people on the individual accounts, the sugar coating for the benefit cut and maybe that works, maybe it doesn't.

The other issue is that Len Berman and I wrote a policy brief in 2001 when we had budget surpluses entitled something like, A Golden Opportunity to Simplify the Tax System. And the motivation for that was precisely what you're talking about now, which is that if you have a surplus, you can clean up the tax system by leaving some people's taxes the same and reducing other people's taxes; that is, you can have a tax cut combined with a simplification. Now, there are losers, there are future generations, but they are not even alive so they're not going to complain about it. So that would have been the time — and this is something we pushed on then — that would have been the time to reform the system in a way that minimized the number of losers. Now we're stuck with revenue-neutral reform because we used the surplus on other stuff and the surplus went away for other reasons, now we're stuck back in this revenue-neutral world where there have to be a fair number of losers. But it could have been different.

MR. MAGGS: Let me just take note and getting back to the original question about you know, what is the real goal of the administration. I guess, I need to take it back in a sense — as you all know, there is no unitary goal when you embark on something like this. There are factions in the administration that want one thing and factions that want another thing and sometimes they're able to come together and intersect enough to announce that there's some big initiative. But the reality is that all through the process there's people that want different things, to a different extent, large reforms, small reform, one of the five easy pieces, there's even disputes about what the five easy pieces are — some see them as one thing, and some see them as another. So, I think the question is, is the perception out there, on K Street — to just use that term, that small ball is the real goal — is that going to interfere with those who hope for something much larger? If I could frame it that way — the internal process in the administration of sorting it out, sorting out what they really want to do —

DR. STEUERLE: Just to be clear, the process is now with the commission and I mean, I think if we want to actually see reform, what we ought to do is put a very strong onus on the chairs of that commission and the members that we're going to sort of hold their feet to the fire if we don't see something good coming out of them, that there's some personal responsibility. I mean, to me in many ways the administration has pushed the tax reform issue off a bit to the side and given it to this commission. But this commission — I have often been surprised at how commission members don't realize the power they have, you know, they're independent. I mean none of them are actually in office — John Breaux, some others might want to run again or something. But they could make a mark for themselves and I think we could actually do well instead of ignoring them, by holding their feet to the fire. I mean they don't have to say anything that the administration — whether they're Democrats or Republicans — they don't have to say anything that the politicians want to say, they can say what they believe is right, if they're willing to do it.

DR. GALE: Yeah, one thing that's interesting about the Tax Reform Commission is the difference with the Social Security Commission, at least the public difference. For the Social Security issue, I think people sort of had to take a public vow that they were in favor of individual accounts or at least it was well known that people were vetted on that issue and had basically signed on. I'm not aware of any sort of litmus test like that on the Tax Reform Commission.

Q: Is it on? David Perdori, Tax Handlers. Speaking of the Tax Reform Commission and losers, the executive order that created the commission — I don't know how many of you have actually seen it — provides marching orders for the commission to take care of homeowners and charitable organizations, and that has been widely thought to mean preserve the home mortgage interest deduction and the charitable deduction. If that is true, and the commission is going to go in with the idea that they're going to preserve the home mortgage interest deduction and broad charitable deductions, doesn't that make — and this is really for all three of you — doesn't that make fundamental widespread reform impossible?

MR. MAGGS: Let me just add, you know, based on things that the president has said, he also says he wants to reduce the disincentives for savings and investment and he wants it to be revenue-neutral. He wants to preserve the mortgage and charitable deductions. A second question is, how do you avoid coming up with a very regressive reform, if those are the criteria that you've got?

Q: Actually, I don't think you can have a very comprehensive reform —

MR. MAGGS: Okay, so your question is can you have reform — can you have reform at all? And I guess my corollary question is, if you have something that's short of fundamental reform and you cue to those principles, how do you avoid making it really regressive or fundamentally regressive? I don't know, Pam do you want to —

MS. OLSON: Well, the progressivity of the current system — I mean, it isn't — that doesn't say anything about what the rates are and the president also said as one of his five items was that he wanted the system to remain progressive and it is a fact that it is on the income tax side that it has become more progressive while he's been president not less progressive. On the low- or moderate-income side, we deliver a lot of things that we call tax credits through the tax system, through the EITC, the additional child credit, all sorts of things like that that are targeted at the low end. Unless somebody comes in and proposes sweeping those out as part of tax reform, you don't end up with something that's more regressive. There's nothing in what the president has said is his principles that would push towards a less progressive system or a regressive system.

Now, I think that as a matter — my personal view is, we either need to change the name of the Internal Revenue Service to something like Finance America or we need to reform the departments that are responsible for administering those social welfare policies and put those social welfare policies in those departments because right now we have — Charles Rossotti, when he was commissioner of the IRS, had some statistics on the funding of the Social Security Administration relative to the funding of the IRS. And you have the, I think the Social Security Administration gets something like two-thirds as much of the budget as the IRS does while the IRS is sending out almost as much in checks as the Social Security Administration is sending them out for a variety of different purposes and for a variety of different people and it's also collecting two trillion dollars. And so if we're going to keep the system as we currently have it with all of this stuff stuck in our tax law, then we ought to look at seriously changing the way that the IRS functions and giving it enough money so that it can properly administer these programs.

The other option, as I said, is to do some reform of the other agencies that — you know, whether you say it's because the politicians are playing games and they want to call something a tax cut that's really a social welfare benefit or whether you think it's a distrust of those agencies, whatever it is, we ought to address that squarely. Because right now, putting this stuff on the IRS is crazy, it's a very ineffective delivery mechanism and that's on the individual side. Then if you look at it on the business side with a variety of things targeted at various investorial sectors through the tax code — what we do is we put the Internal Revenue Service in charge of environmental policy and energy policy and all sorts of stuff that it is simply not equipped to administer. And so, we could do ourselves a significant favor by — I would say most of those things we ought to just jettison, but to the extent that the spending programs actually have merit, they ought to be run by other responsibility for those areas and not by Internal Revenue Service.

MR. MAGGS: So Pam, you think there can still be fundamental reform even if we preserve the mortgage deduction and charitable contributions?

MS. OLSON: Yeah, I mean the real trick is whether because — and a number of people have suggested this already — that because you keep the charitable deduction and because you keep the mortgage interest deduction, that that's the door opening and everything else gets to follow along with it. I don't see why that has to be the case. And obviously, in '86 we succeeded. Not in as wide a measure as Treasury had originally hoped with reforming the individual tax base, but we did make some progress in reforming the individual tax base and I don't see why there's any reason why we can't try the same thing again now.

DR. STEUERLE: I mean, with the space that David — if you add up all the promises made in legislation, they don't add up. We already know we face contradiction and so, whether you take the two or three promises you mentioned, add on the few that John mentioned, and add all the other ones that have been made, they don't add up. You know, the budget, the tax, Social Security, they don't add up. And the art of politics is in part facing up to the contradictions that are made publicly, are made actually many times in legislation and saying, okay, we're going to — how are we going to square this circle? It's basically by not accepting them all. You know, when we did Tax Reform Study in '84, people said you can't change what was then the depreciation system known as ACRS, because the administration just passed it. And we proposed wiping it out and lowering rates instead. Fortunately, we did have a president then who was less concerned with contradictions — some mocked him for this — but you know Reagan was less concerned with contradiction than he was with sort of, sort of — and he wasn't afraid to identify losers either.

I will say that the current era — what scares me is that so many of the politicians on all the sides seem to be so much more scared about identifying losers. You know, like the notion that we can't do anything about current Social Security beneficiees or beneficiaries going to retire in a few years. In '83, we taxed beneficiaries who were going to be coming along in a few years. In the 1970s, we lowered the indexing on some people who were going to get benefits a few years from now. All of a sudden, we're saying we can't create any — you know, sort of like we're trying to create this massive group of people who aren't going to lose as our principle under which we do reform. And as you say, it doesn't add up. So the members of the commission are basically going to have to come in and say, okay, I've got to contradict this on some level.

For the two items you mentioned, I think it's actually not that hard. On charity, it seems to be a charitable deduction probably — at least in my view, it makes some sense anyway, although I might restrict it a little more to make it tighter. And on the whole mortgage interest deduction, there's no reason they couldn't come in as they did so many other times and say, well, we protected some home ownership tax break or subsidy for the middle class but cut back on it for a lot of hiring people and particularly dealt with the ability to arbitrage using mortgage interest deduction and just claim that that's consistent with the principle, even though maybe if you read it word for word, it violates it a little bit. But that's, to me, that's just the art of politics. It's the courage you need of people in the process. That's how we get reform all along the way is we sort of at some level are willing to admit at least internally that there are these contradictions built in and we have to violate some of them.

MS. OLSON: Certainly we can take a trim on the mortgage interest deduction, you know, drop it from a million to 750 or a million to 5 or whatever at which point, you would be providing everybody with some subsidy without providing huge subsidies for the —

DR. GALE: To answer your question directly, I don't think that the commission's statement telling it to preserve benefits for home ownership and charitable deductions is the death knell for fundamental tax reform. And the reason why is I think the death knell for fundamental tax reform has been sounded long before this. It's already dead and what this is, is evidence that it's dead. And it's a crack in the armor in the broad base, before they've even proposed anything. The Kemp Commission did the same thing;

A perfect example of what I think Pam or John said: that the people who would push for these changes aren't necessarily completely happy with the changes that actually end up in the code when all is said and done.

So two last comments: one is, I have to respond to Pam's notion that the system has gotten more progressive since President Bush took office. That's based on a calculation that only looks at the allocation of tax payments across income classes. So for example, if you had the entire tax system and you eliminated it so that we only collected one dollar of revenue from the richest person in the country, by the Bush administration's calculation that the tax system had gotten more progressive because now the rich pay 100 percent of all taxes. What it leaves out is the fact that unless you cut spending, you still have to pay. You still have to raise those taxes at some point. So if you looked at revenue neutral changes; that is, if you financed the Bush tax cuts with any sort of reasonable spending measure, you will see that the system has gotten much more regressive and that only if you look at this one particular, very misleading measure of tax share do you find that the system becomes more progressive.

Last point: what the commission didn't say anything about is corporate subsidies and shelters, and there's a potential — maybe I'm being the Pollyanna now, which would be a rare role for me — (applause, laughter) — that there's a potential that they could go after that big time. And if, for example, any integration scheme could usefully be complimented with anti-sheltering and closing of subsidies, the closing of subsidies is just a tax expenditure issue. The anti-sheltering is in part the book to tax conformity that Pam mentioned. I'd also like to see integration limited to new corporate investment. There's no reason to eliminate the double tax on old corporate investment. That just gives windfall gains to owners of that capital, and we should all agree that windfall gains are efficiency losers and should not be given. But there's a lot of potential things they could do if, as Gene says they step up to the plate and swing the bat, and so I don't find the mortgage/charity thing as distressing as I would have ten years ago when I was thinking in terms of "Let's get the idea/broad base." It strikes me there's still a lot they could do that would actually be good.

DR. GALE: Are we close to our time here? Let's take one more and then — since there's one right there.

Q: I'm Buzz Roberts with Local Initiative Support Corporation. Where does the money come from? If one looks at the big tax expenditure categories, they tend to be things like retirement, health, education, housing. Each one of those really strikes at a fundamental middle class benefit so can you take money away from those and if not, how do you pay for the cuts you want to do?

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