'Is there a solution? Yes: tax reform with a twist.
The problem begins with definitions. By tax reform, Obama means eliminating deductions, exclusions, credits of various kinds with all the money going to the Treasury.
That's radically new. The historic 1986 Reagan-O'Neill tax reform closed loopholes with no extra money going to the Treasury. The new revenue went directly back to the citizenry in the form of lower tax rates.
This is called revenue-neutrality. The idea is that tax reform is a way not to fatten the Treasury but to clean the tax code. It means eliminating special-interest favors and behavior-altering deductions that create waste and inefficiency by inducing tax-preferred rather than market-oriented economic activity. And it introduces fairness by removing breaks and payoffs for which only the rich can afford to lobby.
As a final bonus, tax reform's lower rates spur economic growth. A unique win-win-win: efficiency, fairness, growth.
Obama's own Simpson-Bowles deficit-reduction commission offered a variant. First, it identified an astonishing $1.1 trillion per year of these "tax expenditures." That's more than $11 trillion in a decade. In one scenario, it knocked them all out and lowered marginal tax rates to just three brackets of 8 percent, 14 percent and 23 percent.
But here's the twist. Using the full $1.1 trillion annually of newly redeemed "loophole" revenue, Simpson-Bowles could have dropped the rates a bit below 23 percent. But instead it left some of that money in the Treasury, an average of almost $100 billion a year, or about $1 trillion over a decade. It was a reasonable compromise, so reasonable that even the Senate's most fierce spending hawk, commission member Tom Coburn, signed on.
Now, Simpson-Bowles is not on the table but it could be a model. Obama's "tax reform" would send 100 percent of the revenue to the Treasury. Reagan-O'Neill sent 0 percent. Simpson-Bowles fell somewhere in between. So should any grand compromise.
Before deciding exactly where to locate that compromise, however, we have to decide which deductions to cut, yielding how much revenue. The bad news is that, given all the lobbying and haggling this would occasion, it could take years to work out. The good news is the formula proposed by Harvard economist Martin Feldstein. Before even picking and choosing which deductions should remain permissible, it simply allows no one to reduce his tax bill by more than 2 percent by using any or all of the deductions and loopholes in the current tax code (except charitable contributions).
There should, of course, be separate negotiations over which of the hundreds, thousands, of loopholes/deductions should be tossed out as corrupt or counterproductive rent-seeking. But the 2 percent ceiling means that we don't have to wait until full tax reform — because the Feldstein formula significantly and immediately reduces the impact of all the loopholes.
Feldstein calculates that his tax reform would yield $2.1 trillion in new revenue over a decade'