My Article on tax reform in the Financial Times

Since linking to the FT requires a subscription, here's the full text. This is an argument that I've been making to some of the presidential campaigns.

Copyright 2003 The Financial Times Limited
Financial Times (London)

September 4, 2003, Thursday USA Edition 2

SECTION: COMMENT; Pg. 13

LENGTH: 932 words

HEADLINE: A Bush tax plan for the Democrats: MARK SCHMITT:

BYLINE: By MARK SCHMITT

BODY:
It is worth recalling just how George W. Bush distinguished himself on the issue of taxes in the 2000 presidential campaign. It was not by promising tax cuts: both Mr Bush and Al Gore, then vice-president, pledged to use much of the projected budget surplus to reduce taxes. Nor did Mr Bush emphasise that his cuts would be bigger, or that he would cut taxes "every single year", as his advisers now suggest.

Instead, Mr Bush sold voters a simple and wise principle: unlike Mr Gore, who put forward a tortured programme of incentives to encourage certain activities and benefit certain categories of taxpayers, Mr Bush promised that his policies would not "pick and choose" among taxpayers based upon their source of income or expenses but would benefit everyone and "simplify the code . . . particularly for those at the bottom end of the income ladder".

As Democratic presidential candidates face up to the fact that they cannot restore fiscal sanity or improve healthcare without reclaiming some or all of the Dollars 3,000bn in revenues lost in the three Bush tax cuts, they should not forget this decisive exchange, which was repeated in all three of the 2000 presidential debates. For it contains two lessons in how they should talk about taxes and economics.

First, there is the fact that it is a broken promise. The tax code now does more "picking and choosing" than at any time since the 1970s. While a decade ago there were just three income tax rates, there are now in effect dozens of rates, depending on what year it is and whether your income comes from work, dividends or capital gains. Dividend income alone will be taxed at 10 different rates. The expansion of benefits for the working poor is good, but involves at least four different credits with different requirements, forcing a single parent earning Dollars 20,000 to fill in a tax return as complicated as a millionaire's.

Such a system rewards dishonesty and accounting gimmicks over hard work and real investment. When some investment income is still taxed at both the corporate and the individual level, while other profits are never taxed at all, countless incentives are created to alter business plans to shift income into tax-favoured categories. These transactions absorb money that could otherwise be used to generate growth.

There may be a larger vision here, albeit an unspoken one. Perhaps it is the ideology that investment income should not be taxed at all. Perhaps it is a plan to sow such chaos that a flat tax or consumption tax becomes inevitable. But in any case, the administration has asked to be judged by results - and the results so far are a mess.

Stanley Greenberg, the Democratic pollster, has argued that the most appealing tax changes for voters are reforms such as closing the loophole that allows companies to incorporate tax-free in Bermuda. This is where the second lesson of the Bush-Gore exchanges comes in: such changes are policy specifics, not principles.

Imagine instead that Democrats learnt from Mr Bush and, instead of battling about the details of revenue sources, loopholes and the like, simply put forward a set of principles that should guide the next president and Congress. These might comprise the following. People in the same situation should pay the same tax, whether their income comes from work or investments. Tax rates should be predictable, so people can plan for the future. Total revenues, over the long term, should be based on the cost of the services that voters decide they want from government, so tax cuts, in a time of deficits, cannot be separated from either cuts in services or future tax increases. Middle-class people should not need accountants to do their taxes; and the tax code should encourage low-income working families and reward work, but without unnecessary complexity.

Voters should have a chance to choose between these principles, which are similar to Mr Bush's 2000 promise, and the reality of the current tax code. A Democratic presidential candidate might propose a commission to revamp the tax code from scratch, or some specifics, such as a single tax credit for working families that brings together the four existing, complex credits.

Once before, US politicians confronted a tax code that had gone wildly awry (the top rate was supposedly 70 per cent but with so many exceptions that many wealthy individuals and companies paid nothing) and revamped the code around sound principles: low rates that applied to everyone, incentives for low-income families and simplicity. It was a bipartisan breakthrough, ultimately signed into law in 1986 by President Ronald Reagan. But it met opposition - from a few liberals who liked the higher rates, even if they were entirely symbolic; from lobby groups; and, above all, from powerful Texans, whose oil and gas industries benefited the most from tax shelters.

The lobbyists and the Texans are today even more powerful than in the 1980s. They would love the debate in 2004 to focus exclusively on whether to repeal the tax cuts. Instead, the choice should be between a tax code that distorts the economy and picks winners, and one based on sound principles of fairness and economic neutrality. Such a choice would not only give Democrats an opportunity to spotlight Mr Bush's broken promise but also offer a chance to put America's economy on a sounder footing for the future.

The writer is director of policy and research for the Open Society Institute's US programmes, and was a senior advisor to former Senator Bill Bradley's 2000 presidential campaign