Coburn’s Reforms: Brave but Insufficient

Written by Eli Lehrer on Monday April 25, 2011

Tom Coburn and his colleagues are showing a good deal of courage by putting taxes on the table. But the handful of specifics they’ve offered so far aren’t very promising.

Tom Coburn, hardly a moderate or a shrinking violet by any measure, has effectively “unsigned” Grover Norquist’s pledge not to raise taxes. Coburn’s both right (some taxes may have to go up) and truly courageous (he’s a living example of why tax hikes don’t work). After all, insisting that eliminating any narrow revenue expenditure amounts to a tax hike could make it impossible to reach any sort of agreement on a balanced budget or true reforms to entitlements. That said, two of the details of the Senate Gang of Six Plan that Coburn and others have hinted at -- an avoidance of “middle class tax hikes” and efforts to close “offshore tax loopholes” -- aren’t very promising.

Middle class taxes first.  While raising marginal rates on existing middle class taxpayers isn’t a good idea, there’s a good case for at least some of the “base broadening” that was the key of Ronald Reagan’s 1986 tax reform. Right now, about 50 percent of the population pays no federal income tax at all. While tax-free status is appropriate for the bottom 20 percent or so of income distribution -- many of whom get the Earned Income Tax Credit -- it’s problematic to have removed so many people from the tax rolls altogether. Doing so gives people no stake in the country or responsibility for government services. Even in the context of a revenue neutral tax reform, it might well make sense to hike marginal rates (at least) for some people in the middle.

The idea of closing “offshore tax loopholes” sounds attractive but in fact, isn’t really possible, desirable, or likely to be a sizeable source of revenue. First, the United States’ tax system, alone among the G-8’s, insists on worldwide taxation of income. This results in far fewer “loopholes” than any other big country’s tax system and puts American companies and expatriates at a disadvantage in international business. Some efforts to close so-called “loopholes” (such as the one on offshore reinsurance) would actually amount to tariffs that would likely result in retaliatory trade sanctions. Second, many “loopholes” exist simply because American statutory tax rates are higher than those in other countries. International tax competition keeps U.S. authorities and politicians honest. Finally, like anyone with a lot of money, most big companies--particularly those that sell “weightless” but important products like financial instruments and computer software -- will be able to figure out ways to “manage down” any new tax liability imposed on them. The result of tax barriers won’t be to punish the big boys but, much more likely, to stop smaller, nimbler competitors from taking market-share. Either way, revenues from any offshore-related tax hikes are likely to disappoint.

Coburn and his colleagues are showing a good deal of courage by putting taxes on the table. But the handful of specifics they’ve offered so far aren’t very promising.

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