Eighteen years ago, Congress and President Reagan enacted a tax reform that tidied up the mess quite a bit. Since then, Congress and presidents of both parties have made a new mess, and President Bush is right that it is time for another cleanup. He has called an economic conference this week to mull over some proposals.
The politics may require the lion's share of the mulling. The mechanics of personal income tax reform are straightforward: You end deductions for this, that and the other. Then you can reduce overall tax rates and still raise the same amount of money. Everybody likes the idea of making the tax code simpler and reducing rates. In fact, everybody likes ending deductions too -- in the abstract. But when tax reform zeros in on a deduction they take, people suddenly discover the virtue of complications.
So before Bush reveals the specifics of his promised income tax reform, let's talk about deductions and how they should be judged.
Tax deductions can serve two legitimate purposes. They can make the tax code itself fairer or they can use the tax code to achieve some other social goal.
Fairness, in turn, can mean two different things, which tax mavens call "horizontal equity" and "vertical equity." Horizontal equity means that people in similar economic situations should have similar tax burdens. Vertical equity means that people who are better off should bear more of the tax burden.
Keep in mind, when you're tempted to defend some treasured deduction, that almost every deduction reduces fairness. Bush has said, properly, that he wants reform to be "revenue neutral" -- that is, it should bring in as much money as the current system. So every deduction that survives reform raises the tax rate to ensure this "revenue neutrality." In other words, the cost of saving your favorite deduction will be paid for by all other taxpayers.
When a deduction is supposed to serve some non-tax-related goal, two questions arise: Is this a legitimate goal? And is a tax deduction the most efficient way to serve it? Every deduction intended to serve some non-tax purpose is in effect a taxpayer subsidy of that activity. One problem is that tax subsidies don't get anywhere near the scrutiny that a direct government payment would, though the effect is exactly the same.
