Tax reform is stupid. Here's how to make it smart.

Replace tax breaks with better, more equal programs

Make tax reform smart again!
(Image credit: Mopic / Alamy Stock Photo)

President Trump is by all accounts desperate for some sort of accomplishment, and tax reform is next on the agenda. Yet the Trump administration is quickly finding it to be almost as headache-provoking as health care. When White House Press Secretary Sean Spicer announced that tax reform would abolish the 401(k) retirement tax benefit, for instance, he had to quickly reverse himself after a storm of outrage. As Aaron Blake pointed out at The Washington Post, this is exactly why real tax reform hasn't been passed in decades. It creates too many losers.

But what if that's because the traditional conception of tax reform is outdated and incomplete? Tax breaks work towards many important goals, however poorly. So if you really want to pursue tax reform, you can't just focus on rates and inefficiencies. You should couple it to replacement policies that are more equal and effective.

The usual idea of tax reform is to get rid of inefficient deductions, credits, and exemptions, and plow the money thus raised into lower rates. The conventional wisdom is that this would streamline the process of tax filing, and boost economic growth by getting rid of economic "distortions."

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Now, it is very likely that this sort of thing does not actually boost growth. Even according to traditional economic theory, the main thing holding back growth since 2008 (and arguably long before that) has been insufficient aggregate demand. This sort of structural change is supposed to increase the top speed of the economy. If it is to work, demand must be there to keep the gas pedal pressed to the floor, so to speak — and it has not been for quite some time.

Even that is probably over-generous. The very idea of "distortions" is an exercise in question-begging; it basically assumes a laissez-faire economy is the type of economy which grows fastest, even though the bulk of historical evidence suggests that is not remotely true and never has been. Wealthy, modern economies need a lot of government to keep moving.

However, it is unquestionably the case that various tax subsidies are horrendously inefficient in terms of the policy goals they are supposed to achieve. If you look at direct social spending (stuff like Medicare and Social Security) as a percentage of the economy, the United States comes in towards the bottom of our peer nations. But if you include tax subsidies (stuff like the employer tax exclusion for health insurance — which you should, because they are functionally identical to spending), we are actually towards the top, ranking above nations like Denmark and Finland.

That rather staggering fact — that America, with its millions of uninsured people and no paid leave, does more economic allocation via government than nations with awesomely generous benefit programs — is mostly down to the basic structure of tax subsides. The simplest form of tax break inherently benefits the rich the most, because the more you make, the more you pay in taxes. So if you set up a tax benefit to incentivize homeownership or retirement saving, it means tons of money being plowed into social programs for people who need them the least. Indeed, a couple years ago I added up the price of welfare for 1 percenters alone at over $133 billion, and over $355 billion for the top income quintile.

The 401(k) program is terrible for just this reason. Poor people get nothing, because they make little money (most low-class jobs don't even have retirement benefits), while most of the actual benefit goes to the very rich with lots of taxes to deduct and enough spare cash to hire accountants to maximally game the system. (Meanwhile, most middle-class people who manage to use the benefit fall victim to swindlers who heavily advertise their rip-off mutual funds.)

Of course, it's perfectly understandable why people who have worked hard to save for retirement would be infuriated at the idea of losing their tax benefit. The solution is not to bemoan the intransigence and selfishness of people, but propose a replacement policy that is more efficient and more equal.

So instead of just getting rid of the 401(k), replace it with a big increase in Social Security, across the board. Instead of just getting rid of the mortgage interest deduction, replace it with a universal housing voucher that could be used for rent or a house payment. That approach, applied across the whole policy universe, could make taxes simpler, more efficient, and dramatically improve the lives of the vast majority of American citizens.

Only the top 5-10 percent of people would come out behind, since they benefit disproportionately from the current system. But universal programs have the potential to activate a wide constituency to counterbalance certain enraged resistance from the rich. If we want to get tax reform done properly, that's where the necessary political support must be found.

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