Red State Tax Reform

I was at a panel discussion earlier this week with Gene Steuerle of the Urban Institute, who said that he was skeptical that the Bush administration would propose a serious overhaul of the tax code because, "I know what it looks like when people are working seriously on tax reform, and I'm not seeing it." As a Treasury official in the Reagan era, Steuerle was one of the architects of the 1986 Tax Reform Act, so he does indeed know what it looks like, probably better than anyone.

Today's Washington Post brings news that the administration is considering some sort of tax reform short of a national sales tax or Value-Added Tax, ideas which were never in the cards. Instead, Jonathan Weisman reports, "the contours of a tax plan are taking shape: lower individual and corporate tax rates and steps to broaden the base of taxation and promote growth by cutting taxes on investment."

"Broaden the base," considered one of the basic goals of any tax reform, generally means reducing the categories of income that are exempt from taxation. Broadening the base, by eliminating special treatment of various kinds of investment income, in exchange for lowering rates, was the hallmark of the 1986 reform. But nothing else that Weisman reports suggests that what the White House is considering has anything to do with broadening the base. The favorite policy would be to create expanded savings accounts that would shelter investment income from taxation entirely, and the article suggests that the White House might pay for them by eliminating the corporate deduction for health insurance and the deductibility of state and local income taxes. That's not broadening the base -- at best it's shifting the base, or the tax burden, away from wealthy investors and onto most ordinary people who benefit from these deductions, or in the case of the first, from employer-paid health insurance.

(Which raises again the question, asked here before: Why is the President Determined to Destroy the Private Health Insurance System? It's one thing, albeit shameful, to want to do nothing to expand health care and to oppose proposals such as Kerry's that would slightly expand government's role in order to make the private system work. It's another thing to actively work to break an already fragile system, with no alternative in mind.)

Back to the question of the deductibility of state and local taxes: This was one of the big questions in 1986. Tax reform purists would like to eliminate the deductibility of state and local taxes, on fairness grounds as well as base-broadening. It provides a benefit only to taxpayers who itemize deductions and benefits those who live in high tax states. There is a strong policy argument on the other side, for keeping the deduction, but it's all academic: As the reformers found in 1986, it's a non-starter. Senator Moynihan put his foot down that year on behalf of New York, and there will always be enough votes from relatively high-tax states that deductibility will live on.

Except this time I wouldn't be surprised if the Bush administration is looking at the map and thinking blue state=high tax=screw 'em! But that's not quite right. Look at the CNN/Money Magazine ranking of states by tax burden (this data comes from the Tax Foundation and is flawed in several ways, especially because it includes sales taxes which are not deductible, but this is what legislators will be looking at). Not surprisingly, New York and DC are at the top of the list -- no Republican Senators at risk there. But close behind are Maine and Ohio (Snowe, Collins, Voinovich and DeWine are already the four Republican Senators the administration would be most worried about defecting on a tax bill, in addition to Chafee), Utah comes up fairly quickly, as does Idaho. That's more defections than they can afford.

Bottom line: they're not serious about this. As Steuerle said, the lights are not burning late into the night at the Treasury Department.