Pathways to Tax Reform Revisted

The U.S. income tax badly needs reform. It is complex, unfair, and inefficient. It doesn’t come close to raising enough revenue to finance government expenditures, and won’t any time in the foreseeable future unless it is revised. Raising tax rates could increase revenues, but it wouldn’t lessen the complexity and would magnify the unfairness and efficiency costs. Not surprisingly, proposals for reform abound. Income tax reform proposals would virtually all trim so-called tax expenditures, the 200 or so exclusions, deductions, and credits that are designed to provide subsidies for particular activities or groups. This would surely make the late Stanley Surrey smile. He invented the term tax expenditure and instructed the Treasury Department to compile a list and tally up their cost. He viewed cuts in tax expenditures as the “pathway to tax reform, ” and in 1973 made the case in a book of that title. Surrey and latter-day reformers are surely right that cutting tax expenditures could raise revenue while reducing the economic cost of the tax system and making it simpler and fairer. The only drawback is political: voters like tax expenditures, the biggest of which are the mortgage interest deduction and the tax break on employer-sponsored health insurance. Simply eliminating people’s favorite tax breaks is unlikely to win much public support. This paper revisits Surrey’s pathway, examining various proposals to eliminate, reduce, or reformulate tax expenditures as part of tax reform. I start by outlining the need for tax reform. Then I examine various proposed paths to achieve it. I discuss options to cut tax expenditures and the efficacy of a VAT or carbon tax as a supplement to the income tax. The concluding section summarizes the potential pathways and a few dead ends on the way to tax reform. Key Words: Tax Expenditures; Federal Budget; Deficits; Tax Reform JEL No. H21, H24, H50, H60