Senate Budget Committee hears tax reform urgently needed, but tough to achieve

By Jon H. Harsch

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WASHINGTON, Feb. 2 – In a Senate Budget Committee hearing Wednesday on “Tax Reform: A Necessary Component for Restoring Fiscal Responsibility,” Committee Chair Kent Conrad, D-N.D., warned that “Our tax code is out of date and clearly hurts U.S. competitiveness.” He charged that “the combined effect of the tax gap, offshore tax havens, and abusive tax shelters is leading us to lose more than $500 billion a year” – a cost that's indefensible at this time of massive federal deficits.

Conrad added that “the tax code is riddled with expiring provisions. This creates enormous uncertainty for citizens and businesses, making it difficult for them to plan.” He said the good news is that “If we took steps to simplify and reform the tax code, we could reduce tax rates below where they are today and still get more revenue. . . If we were to broaden the base and fundamentally reform the tax system, we could actually lower rates, helping America be more competitive and generate more revenue.”

Conrad's call for tax reform got lots of support from the hearing's panel of tax experts. But they also warned that since the tax code is complex and since any change inevitably creates some losers, any reform will be difficult. They pointed to political difficulties in particular. Urban Institute Fellow Eugene Steuerle explained that the dilemma for Republicans is that if they agree to raise tax rates to balance the budget, their fear is that this will simply enable increased federal spending. He said the mirror-image dilemma for Democrats is that if they agree to spending cuts, their fear is that the resulting reduction in the deficit will be used to finance tax cuts.

Steuerle concluded that the answer is to “come up with budget rules that limit both political parties, whether they're in power or not in power.” He sees that as the only way to escape the current impasse. He said that except for last year's healthcare reform bill, “most members in today’s Congress have never voted for any significant deficit reduction or for the systemic reform of any major spending or tax program. Both deficit reduction and systemic reform, you see, require identifying 'losers' – those who must give up something . . . both political parties for a long time have only enacted tax cuts and spending increases while hoping that the other party will enact the tax increases and spending cuts that balance the government’s books.”

Conrad pointed to the problem of unrealistic thinking: “Looking at revenues has led some to argue that revenue should be held at the historic level over the past 40 years, about 18% of GDP. Revenues, I want to point out, at that level would not have produced a single balanced budget in all of that time, because spending exceeded 18 percent of GDP in every year. In fact, on the five occasions when the budget has been in surplus since 1969, revenues have ranged between 19.5% of GDP and 20.6% of GDP. It is this higher level of revenue that I believe provides a more useful guidepost for what is needed if we hope to dig ourselves out of the fiscal hole and set the budget on a sustainable path. Let me indicate that would mean we would have to have very significant cuts on the spending side, because we are . . . over 24% of GDP on the spending side.”

Conrad also highlighted the problem of tax breaks. Along with broadening the tax base, he called for “eliminating or scaling back so-called tax expenditures.” He said “Tax expenditures are all of the deductions, exclusions, credits, set-asides in the tax code. They are costing the Treasury more than a trillion dollars in revenue a year. That matches all of domestic discretionary spending.”

Conrad said that “To solve the long-term challenge, it will require real compromise and a great deal of political will. We need everyone at the table, and we need to have both sides, Democrats and Republicans, willing to move off their fixed positions in order to achieve a result important for the nation. We cannot continue to put this off. We need to reach an agreement this year. It is time, I believe, for the administration, leaders of Congress, Democrats and Republicans, to sit down and hash out a long-term plan.”

The panel of experts generally agreed that at least part of any plan should be shifting the U.S. from its current complex income tax system to introduce the value added tax (VAT) system now used in most other countries.

Both Conrad and Budget Committee Ranking Member Jeff Sessions, R-Ala., pointed out that the VAT approach is unpopular in the U.S. Sen. Sessions said Americans' concern with a VAT consumption tax is that it would “make another revenue stream possible for the government to extract a larger percentage of their wealth to send to Washington.” He asked one witness, Lindsey Group President & CEO Lawrence Lindsey, whether VAT could be introduced “in a way that would give confidence that we weren't just adding a new way to extract more money from the American people.”

Lindsey answered that the way is to scrap as much of the present tax system as possible and replace it with a VAT tax. But Lindsey added that economists making the VAT case have the advantage that “We don't have to run for reelection.” In fact, that's an advantage Lindsey shares with Sen. Conrad who has announced that he will not run for reelection in 2012.