Friday, May 08, 2009

Stasis in Tax Policy: Further Thoughts

In my post on Tuesday of this week, I discussed the Obama administration's recent proposals to change the taxation of foreign-earned corporate income. I concluded that the emerging debate about those proposals demonstrates that we might have reached the point where no tax policy changes are politically possible except those that make absolutely no one unhappy. Today, I will expand on that argument to suggest that the problem of political stasis has its roots in two basic phenomena: (1) Anything that can be called a "tax increase" is now political poison, and (2) It is always possible to oppose a tax increase by looking only at its possible negative consequences, ignoring the possible benefits of the tax increase as well as the possibly worse consequences that might follow if we reject the tax increase at hand.

The tax changes that the administration has proposed are of two basic types, First, Obama's people are trying to close some fairly glaring loopholes in the law; and second, they are trying to change the way the laws are enforced in order to collect more of the taxes that are already legally collectible. Both types of changes will (by design) raise tax revenues, and I said on Tueday that it is "a completely reasonable definition of what it means to increase taxes" to say that "some taxpayers will pay more tax if [a tax proposal] is passed than if it fails." Is that really so reasonable?

Take loophole closers first. If a taxpayer has been taking advantage of an unintended interplay between two provisions in the tax code, and if Congress fixes that unintended interplay, the taxpayer's only complaint seems to be that she should be allowed to continue to exploit an advantage because she has already been exploiting it for awhile. Imagine that a law was written that applied one tax rate to those "18 years and older" and another tax rate to those "under 17"; if a 17 1/2-year-old figures out that she fits neither category and thus pays no taxes, it would seem odd to say that she is the victim of a "tax increase" if we fix the rule to sweep 17-year-olds into one category or the other.

Enforcing unenforced rules is even more difficult to vilify. If a taxpayer has been under-reporting income (or declaring phantom deductions) for years without having been caught, it is truly perverse to argue that she is somehow the victim of a "tax increase" if we put in place mechanisms that will make it easier to detect and punish underpayments of the tax law as it is already written. Even so, the sense of entitlement can be powerful. Back in the 1980's, bankers waged a successful lobbying campaign against a proposal to withhold taxes on interest income by putting up signs in bank lobbies (remember the inside of banks?) urging depositors to call Congress to oppose this "tax increase." That the purpose of the proposal was to reduce outright tax evasion did not seem to matter.

Still, both loophole closers and enforcement crackdowns do result in more tax revenue being collected from some unhappy people, and it is thus accurate to say that taxes have been increased. The problem is not ultimately in describing all increases in tax revenues as "tax increases" but in the fact that we have reached the point where all tax increases are viewed as being bad, bad, bad. If those who wish to change the tax laws in a way that will raise more revenue must always fight a rhetorical battle against having "raised taxes," then the answer is not to play games with what counts as tax increases but to admit that sometimes (either for revenue reasons or to improve the consistent and rational application of laws) some people will need to pay more in taxes. No one in American political life today seems willing to make that case.

In my Tuesday post, I mentioned a New York Times editorial that opposed the Obama tax proposals in part on the basis that forcing American companies operating abroad to align income and deductions in the same year (closing the deferral loophole) might cost American jobs, because some of the deductions affected by the proposal are for expenses related to domestic support operations for generating foreign income. This objection is a fine example of the second part of the current sad state of tax debate in the U.S. For starters, the editors of the Times do not even hint at whether their concern is backed up by anything other than the idea that taxes can create behavioral changes. They do not even refer to anecdotal evidence, much less any kind of independent analysis that might suggest that this problem would be a matter of real concern (and quantitatively meaningful). If we allow this kind of argument to have any sway in tax debates, however, then every tax -- when viewed in isolation -- will be quite easily characterized as harming something. Tax three-martini lunches? Busboys will be laid off. Tax fatty foods? Struggling single moms working in bakeries might be thrown in the streets.

Moreover, arguments like those in the Times are an example of how cost-benefit analysis has been replaced with what we might call "cost-only analysis." The proposal in question is not evaluated on the basis of what it might accomplish, or on the basis of what its adoption might help us to avoid, but only on the basis of what might be the downside of the tax change. In this instance, the Times' move is especially unforgivable, because the administration explicitly tied the revenue from their proposed tax "increases" to the ability to fund an extension of the tax credit that companies can use to fund research and experimentation.

More generally, even if two tax proposals are not (somewhat artificially) tied together, it is certainly true that not collecting revenue as proposed will have consequences. Either other taxes must be increased, the deficit must go up, or some spending somewhere must be cut. If it is the latter, we do not know whether the cuts will come from good things (cancer research? bridge repair?) or bad (Congressional travel junkets? waste, fraud, and abuse?). None of those alternatives is consequence-free, but we have come to act as if we have done something virtuous by opposing a tax change on the sole ground that it might have a negative consequence. Even for those who are generally skeptical of government spending and taxes, that is no way to make decisions.

-- Posted by Neil H. Buchanan


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egarber said...

It seems your point parallels in some ways the lack of "externalities" in today's accounting standards.

When it comes to environmental impact for instance, all we talk about is the "cost" imposed on a company. Well, if accounting rules captured external impact in the first place, the conversation would be very different. There would be a cost associated with doing *nothing* -- because on some individual or aggregate balance sheet, the fact that I pollute would already be counting against me.

Similarly here, there's no real effort to acccount for the no-action scenario. Or at least that side of the debate is largely muted.

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