A New Tax Debate

When Barack Obama took office two years ago, four far-reaching problems stood above all others he had to face: the free-falling economy, the war in Iraq, the health-care crisis, and the threat of global climate change. If he could make real progress on those four, his presidency could stand among those of Franklin Roosevelt, Lyndon Johnson, and Ronald Reagan as the most consequential of the last hundred years, no matter what else he did or didn't do.

So far, the record on these grand priorities is mixed. The economy is recovering, but far too slowly; we are no longer fighting in Iraq, but Afghanistan has shown itself to be even more of a quagmire; Obama did pass historic health-care reform; and action on climate change has effectively been shelved. But as Obama looks toward the second half of his first term, there is another way for him to do something historic: reform the American tax system.

It's an enormously complex challenge, both substantively and politically. We haven't had a major overhaul of the tax code in a quarter-century, since Ronald Reagan and Tip O'Neill cooperated to lower rates (the top marginal rate went from 50 percent to 28 percent), increase the alternative minimum tax, and eliminate some tax shelters. That reform took a couple of years to pass, but it did in large part because it contained important provisions that both Democrats and Republicans wanted.

Another round of tax reform is long overdue, and this is exactly the right time to get started. We're in the final stages of a maddening debate about just how much lucre should be showered on the Paris Hiltons of the world, all because of a trap laid a decade ago: Their expiration forces Democrats into the position of trying to raise taxes. The compromise on extending the Bush tax cuts, which President Obama is now trying to pass through Congress, may have laid another trap. Because the cuts are being extended for only two years, we'll have this debate all over again in the heat of the 2012 presidential campaign.

So what Democrats need is an entirely different tax debate, one that isn't about whether we should raise or cut taxes but whether we can reform our tax system in ways that work to (nearly) everyone's benefit. It will be a lengthy process, but it doesn't have to be one that falls cleanly across the usual cut taxes/raise taxes lines.

There are a number of ideas already out there about how the American tax system might be reformed. As Democrats work toward a plan, they should be guided by a few values. Any reform of the tax system should make it fairer, simpler, and more likely to reward work.

Let's take fairness first. There are a number of ways to achieve it, but the simplest is that everyone should pay their fair share -- no more, no less. This will be a point of contention, but Democrats would go a long way toward achieving fairness if they insist on this simple principle: All income should be treated the same. Right now, income you get from working is taxed at a higher rate than income you get from your investments, which is absolutely backward. But Democrats haven't been able to bring wage taxes and investment taxes into alignment because they haven't framed their argument in terms of wage income. Articulate the simple principle, and it becomes nearly impossible to contradict. How many Republicans would want to argue in public that investors deserve better treatment than people who work for a living?

Treating investment income the same as wage income would also make the code simpler. Most important, simplifying the code would mean eliminating the hundreds of specialized breaks and deductions of which the wealthy and corporations are so adept at taking advantage. For all the complaining Republicans do about high corporate tax rates, corporations themselves like the current system just fine. Most corporate income is supposed to be taxed at a rate of 35 percent, but corporations have learned to play the tax code like Heifetz wielding a Stradivarius. General Electric, for instance, made a $10.3 billion profit in 2009 and not only didn't pay a cent to Uncle Sam but actually got a $1.1 billion refund. And the richer you are, the more likely you are to have the kind of complex sources of income that can be exploited to minimize your taxes. Simplifying the code would save all of us money and time; according to the government's national taxpayer advocate (did you know there was such a person?), 7.6 billion hours are spent every year complying with tax-filing requirements.

Multiple plans for fundamental reform are already circulating around Washington, and many if not most have the virtue of offering things both conservatives and progressives can get behind. One plan in Congress, from the bipartisan team of Sens. Ron Wyden and Judd Gregg, has been praised by the likes of the Heritage Foundation and former TAP writer Ezra Klein. What that tells us is that while the tax-reform debate could become a hardened partisan battle, it doesn't have to be.

On Friday, The New York Times reported that the administration was beginning to plan for tax reform. According to the officials quoted in the story, however, they're not in any particular hurry. "Administration officials cautioned," the article said, "that no decisions have been made and that any debate in Congress could take years." They seemed to be at pains to keep anyone from concluding that they felt any urgency to advance tax reform.

They ought to start feeling urgency, though. No one is naive enough to think that tax reform will be easy. Every deduction you eliminate has a highly motivated group ready to fight to the death to retain it (and just try touching something like the mortgage-interest deduction, which next year will cost the Treasury over $100 billion). The process could take years of hearings, studies, and negotiations. But starting now means we could debate tax reform through 2011 and 2012, then perhaps pass it in 2013. It would be a pretty good start to Obama's second term.

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