Zeroing in on simplifying the tax system

By all accounts, America has a messy tax system: Businesses appear to pay taxes based on the quality of their accountants rather than on any reasonable measure of their profits, a profusion of loopholes has narrowed the range of income taxed, and compliance costs rank among the highest in the world.  

Economists on the left and the right agree that a simpler tax code with fewer loopholes that taxes a broader range of income at lower rates could encourage investment and hasten economic growth. But getting to a simpler tax code is hard. 

{mosads}The last major federal tax reform, in 1986, strove to create a better, simpler code, but nearly all of the loopholes that once larded the tax code have returned since then. However, the most radical existing plans for wholesale tax reform currently on the table are fatally flawed. The Fair Tax would, among other things, impose enormous levees on doctors’ bills, home purchases and other things lightly taxed today. A national Value Added Tax would be incredibly regressive. 

Rather than a single wholesale reform — most of which involve trade-offs that could do a lot of harm — the best way to improve the tax code could be to borrow from an old idea called “zero-base budgeting.”  

Zero-base budgeting, which reached its apogee in the 1970s, is a system for managing expenditures that analyzes programs as a whole rather than only changes in spending levels. Zero-base budgeters assume that the “base” budget is “zero” rather than what was spent the previous year. For each category of expenditure, evaluators ask two questions: “Are the current activities efficient and effective?” and “Should current activities be eliminated or reduced to fund higher priority current programs or reduce the current budget?” Because the process generates much more paperwork than conventional budgeting methodologies, zero-base budgeting proved unworkable as a yearly exercise. 

What didn’t catch on widely for evaluating spending, however, might have a lot of promise for simplifying the tax code. Rather than a “zero base,” a procedure for developing a tax code would begin with a “flat base”: an assumption that the federal government would tax all income from all sources at a level at least sufficient to maintain current levels of revenue. 

All current deviations from that flat base would require evaluators to ask and answer two questions: (1) “What goal or relevance to a national government (if any) does this provision attempt to accomplish?” (2) “Is this goal most efficiently and effectively achieved through the tax code or by some other means?”

A look at what might be the single most sacred provision in the tax code — the deduction for almost all mortgage interest on first and second homes — reveals how these questions work. In response to the first question, the societal consensus seems to be that the government should help people of modest means afford homes. However, in response to the second question, the mortgage interest deduction fares quite poorly by any objective measure. Many people who benefit from the deduction right now could easily own homes even without the deduction. Some sort of grant program for first-time home buyers could likely encourage home ownership more effectively and at a much lower cost to the federal Treasury.

Similar tests can be applied to nearly every part of the tax code, and most current provisions would fail at least one of them. If posed in terms of great national interests, most narrow provisions — special credits for certain water heaters and tax breaks for opening new oil wells — are testaments to the power of certain lobbying groups rather than the national interest. Other provisions, such as the limitless deductibility of employer-provided health insurance, might advance legitimate goals of the national government but are costly and ineffective.

Developing a flat-base tax code will require conservatives to support new spending programs to replace ineffective tax provisions targeted toward worthy goals and liberals to admit that certain tasks now carried out through the tax code ought not to involve the federal government at all.

A flat-base tax reform process isn’t a panacea and it won’t disarm the special interests that lard the tax code or balance the budget. But looking at tax code provisions differently could point the way toward a better manner of funding government. 

Lehrer is vice president of The Heartland Institute. Brannon is director of economic policy at American Action Forum.