T.R. Reid Explains Why Democrats Should Get On Board the Great Tax Reform Of 2018

In Full Archive by Nathan Lewis

(This item originally appeared at Forbes.com on January 4, 2018.)

https://www.forbes.com/sites/nathanlewis/2018/01/04/t-r-reid-explains-why-democrats-should-get-on-board-the-great-tax-reform-of-2018/#24b65f3c1091

I knew the Washington Post reporter T. R. Reid from his book Ski Japan!, which I used to explore Japan’s major ski resorts twenty years ago. Thus, I am intrigued to see him take on the issue of tax reform, a topic dear to my heart, in A Fine Mess: A Global Quest for a Simpler, Fairer, and More Efficient Tax System (2017). As befits a foreign correspondent, the book is international in scope, covering with considerable sophistication the tax policy developments in New Zealand, Slovakia, the Netherlands, Japan or Britain. It is also pleasingly even-handed, without the usual party-line bias that infects work in the U.S., although I would say there is definitely a leftward lean – again, a common characteristic among newspapermen.

U.S. business-friendly conservatives will find much to like; also, Democrats might learn again why the big tax reforms of the 1980s were embraced by both parties. The 1986 tax reform, in which the top personal income tax rate fell to 28% from 50%, passed the Senate 97-3. The legislative push was led by Bill Bradley, a Democratic senator from New Jersey – ironically, the same Bill Bradley that defeated Republican supply-side tax-cutter Jeff Bell for that Senate seat in 1978.

Reid concluded that the U.S. tax code is so overcomplicated that it is time to write a new one from scratch. This is a theme that is popular among Republican tax reformers, with Flat Taxers on one side, unified sales taxers (“Fair Tax”) on the other, and a variety of hybrids in between, such as the “9-9-9” plan of Herman Cain, or the “business flat tax” that Ted Cruz proposed in the 2016 presidential primaries.

T.R. Reid argues for a whole new tax system with a “broad base and low rates.”

But, what should this new tax system look like? Reid looked at what has worked around the world over the last thirty years or so. Some of it is surprising: Japan and Britain both use a “precision withholding” system, where the tax agency computes your taxes for you, with the result that only about 20% of taxpayers need to file any additional material. You just check a box that you agree with the revenue department’s conclusions. (I bet that helps to avoid audits.) California experimented with a similar program in 2012, which had a 98% approval rate from taxpayers that tried it.

Reid concluded – remember, this is from a slightly left-tinged standpoint – that a “broad base/low rate” approach is best, and that the system should be as simple as possible, with a minimum of exemptions, exclusions, and so forth – none is better. Even the simplest things can become quite absurd. Reid noted that an exclusion of groceries from VAT led to the definition of 1-5 doughnuts as a “restaurant meal,” and 6 or more doughnuts as “groceries.” This “BBLR” approach (apparently, tax economists actually say this so their mouths don’t get tired) can take the form of a consumption-type tax such as a sales tax or VAT, with as few exceptions as possible; or an income-type tax, again with as few exemptions or other “tax expenditures” as possible. In both cases, tax rates should be as low as possible.

Given this, it is somewhat bizarre that the book stumbles badly in its discussion of “flat tax” income tax systems, as were widely employed in the former Soviet sphere after 2000. Certainly, that plan fully embraces the “broad base/low rate” principle. Reid complained about the lack of “progressive” tax brackets, without explaining very well why. Most “Flat Tax” proposals have a substantial basic deduction: in effect, there are two tax brackets, 0% and the “flat” rate of perhaps 17%. In The Flat Tax Revolution (2005), Steve Forbes laid out a plan that included a $46,000 basic deduction for a family of four. (I believe this would be adjusted for the CPI, and would be higher today.) Thus, a family making $100,000 a year would be paying 17% on $54,000 of that, which is an overall tax burden of 9.18%. Very high incomes would asymptotically approach 17%. Reid made no mention of this, although, considering that he referred to Forbes’ book by name, he must have known about it.

It’s true, as Reid noted, that some former flat-taxers in Eastern Europe have recently added higher tax brackets. Reid insisted that this is because “a flat tax can’t generate enough revenue,” and then explained that the higher rates came about because a) a falloff in revenue due to the financial crisis of 2008; and b) because the EU cut subsidies to these governments, arguing that they were doing well enough on their own. The entire discussion is rather disingenuous, and I would not be surprised to find that the new systems, with the higher tax rates, generate no more revenue (as a percentage of GDP) that the original flat-tax systems — just as those flat-tax systems, when instituted, did not generate any less revenue/GDP than the highly-progressive systems they replaced. What we do know is that the stunning growth rates of these “flat taxers” before 2008 fell to much more modest levels as tax rates were raised (including VAT and payroll taxes) after 2009. That weak recovery and slow growth had enormous negative consequences for tax revenue.

The book lacked discussion, or much apparent awareness, of many other issues that lie at the core of tax policy. Reid constantly praised the “BBLR” approach for its economic efficiency (that is, it doesn’t impede business), and then disparaged “supply-sider” claims that tax reforms create more economic growth, and consequently, more tax revenue. These are one and the same: “economic efficiency” is “more growth.”

Nor did he have much appreciation for the fact that lower tax rates lead to more taxable activity: you get less of what you tax, which means that you get more of what you tax less, which means that lower tax rates don’t produce a proportional falloff in tax revenue because the lower rates apply to more taxable activity – the principle of the Laffer Curve. Some academic studies have found that the “elasticity” of taxable income can be nearly 1.0 for corporations. In other words, a 10% lower corporate tax rate results in 10% more taxable income, and thus unchanged revenue. Even this does not include growth effects – lower corporate taxes can lead to more growth overall, which means more revenue from all other taxes. Nor does this include spending effects: a healthier economy, perhaps due to lower corporate tax rates, produces less demand for government services and support, which allows less spending. A reduction in the corporate tax rate in Britain from 28% in 2010 to 19% today was accompanied by a reduction in government spending by 5% of GDP, and a reduction of state employee headcount of a million people. Winning. That’s why I elevate “Low Taxes and Stable Money” to the level of a “Magic Formula,” much as Adam Smith did over 200 years ago.

Reid also seemed to favor the idea of “taxing all income the same,” such as applying top income tax rates to capital gains. This idea has never worked in practice – I don’t know of a single OECD government that does it, not even commie-socialist France, although I could name quite a few that don’t tax capital gains at all, including Hong Kong, Singapore, New Zealand, Belgium, Germany, Malaysia, the Netherlands, South Korea, Switzerland, and, during its high-growth years but alas no more, Japan. This was tried in the U.S. in 1986, and quickly abandoned; further capital gains tax reductions in 1997 (with broad Democratic support) helped fire up the economy and produce a budget surplus. Among many reasons not to tax capital gains, one the best is that it tends to have strong negative growth effects, all out of proportion to its modest revenue.

A lot more can be said about these topics. Nevertheless, the conclusion tends to be the same: a “broad base/low rate” approach that tends to mean, in real life, a sales tax/VAT and an income tax that is very much like today’s “flat tax” proposals with a top rate below 25%, even if, perhaps, it has more than one tax bracket. Singapore’s income tax system has ten tax brackets and a top rate of 22%. That seems a little silly, but I could live with it. (As noted, the large basic deduction in most “flat tax” proposals accomplishes almost the same thing.)

Reid suggested that this clean-sheet-of-paper rewrite of the U.S. tax code should be done in 2018. I suggested the same thing (perhaps with passage in 2019). Reid’s book showed that this can be a centrist issue also supported by a broad swath of Democrats. This time, maybe it will pass the Senate 97-3.