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Democracy & Technology Blog The Tax Reform Swamp

“The President’s Advisory Panel on Middle Class Tax Hikes”

That’s what the Free Enterprise Fund is calling the Tax Reform Commission that met for the 11th time this year on Tuesday. The meeting focused on ways to limit the home mortgage deduction, thus raising revenue to “pay for” the elimination of the Alternative Minimum Tax (AMT). Although we don’t yet know what the Panel’s final report will say when it is released on November 1, it looks like its recommendations will be much less ambitious than many of us would like — and less ambitious than the U.S. economy needs.

News accounts today suggest that the major “reform” will be elimination of the AMT in return for limits on the mortgage deduction, employer health plan deductions, and other similar items. Maybe some further tinkering, but not much more. This is tax reform? Such a narrow and small-minded (not to mention politically and economically dumb) effort is hardly even worthy of the low regard heretofore achieved by Presidential commissions. Watching some of the hearing on C-Span, it seemed the focus was on the U.S. housing market and Americans’ lust for large homes.

Yes, we need to eliminate the AMT — really the alternative maximum tax because they make you pay either the regular tax or the AMT, whichever is more. It will begin hitting more and more middle class families in the coming years. But because the AMT will hit mostly coastal blue states, many Democrats would have been persuaded to go along with AMT elimination anyway. AMT elimination should be just a part of major tax reform; it shouldn’t be the whole reform. It’s also fine with me if we do away with the mortgage interest deduction, provided the rest of the reform is comprehensive and thoughtful enough to compensate for the negative impact of the loss of the deduction.

The most important item in tax reform is to slash the marginal tax rates on income and capital, preferably eliminating taxes on capital altogether. The Panel heard from many distinguished economists and policy experts who favor a number of plans that do this. The Panel could easily just have mailed Steve Forbes’s new book, The Flat Tax Revolution, to 1600 Pennsylvania Ave. and called it a day. Or go with Arthur Laffer’s solution, which really minimizes tax rates: a dual tax with very low rates, one on personal income (properly defined) and the other on business value added. We’re talking maybe 9 percent on each. Two taxes applied to the same broad base captures GDP twice and allows you to really get the rates down, thus minimizing economic distortions. Other plans based on a national sales tax can achieve similar economic efficiencies, though many quibble with implementation issues. Any of these would be far better than the current system.

Coming out of yesterday’s hearing, most pundits today focused on the feasibility and economic effects of a mortgage deduction limitation. But conservatives should not get bogged down in this diversionary backwater, as they did on the minutiae of Social Security “solvency.” They are missing the ocean of possibilities to which a big, bold tax reform could lead. Only a focus on top line growth and opportunity can win these debates, where so many politicians, lobbyists, and demand-side economists have so much to lose. Playing in their zero-sum swamp is a losing strategy.

Let’s recap: Social Security reform, which focused on ugly benefit cuts and ignored the wealth creating possibilities of personal accounts (or just plain reduction of the payroll tax), was a disaster this year. Our stance toward China, which favors currency instability and possible trade restrictions to seek some elusive “balance of trade,” is self destructive. Katrina spending has pushed back indefinitely the elimination of the death tax and extension of the 2003 tax cuts. Now if tax reform goes down also, we will have squandered all of our best opportunities to prepare and propel the American economy into the next era of intense globalization. The flat tax is sweeping the world, and America is stuck talking about square footage and static scoring.

Let’s hope former Sen. Connie Mack and his Panel pull a Flat Tax rabbit out of the Revenue Code quicksand.

-Bret Swanson

P.S. As long as we must talk about the mortgage deduction, let’s consider Arthur Laffer’s solution, which is both economically and politically sound. Allow deductions for interest expense. But tax interest income. Simple. And it saves the mortgage deduction that worries so many.

Bret Swanson

Bret Swanson is a Senior Fellow at Seattle's Discovery Institute, where he researches technology and economics and contributes to the Disco-Tech blog. He is currently writing a book on the abundance of the world economy, focusing on the Chinese boom and developing a new concept linking economics and information theory. Swanson writes frequently for the editorial page of The Wall Street Journal on topics ranging from broadband communications to monetary policy.