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Why great tax ideas won’t be implemented

March 21, 2012

Every so often someone comes up with a new tax reform idea. They usually boil down to broadening the base (fewer exemptions) and lowering the rate, taxing externalities and rents, and/or reducing complexity. While all of these ideas are good, and they would increase economic growth, bring transparency to government, give everyone a puppy, etc, they won’t happen under the current political system, at least not permanently.

To see why, think about what politicians do – they have to convince people to vote for them. If the tax base is broad – everyone gets taxed, no exceptions, politicians can’t trade loopholes for votes. If the tax rates are low, people won’t have much of an incentive to lobby to lower them. If the system is clear, people will realize when they are being taxed, and resent the government for taxing them. Better to obfuscate taxes behind a huge wall of bureaucracy and indirect taxation, such as the payroll and corporate taxes.

We also have to think in terms of dynamic policy. The tax system isn’t static and complicated, it is becoming more complicated over time. When a special interest group goes to a Congressperson, and they can get a tax break in exchange for campaign contributions. For example, in the 1986 Tax Reform Act alone, there were around 650 tax exemptions for specific firms and individuals. But once someone’s got their personal handout, why give any more to Congress? That’s where tax reform comes into play. Congress gets a change of heart. They see the light. It’s time for a new, efficient, loophole-free system to improve economic growth, and a year later, they are out selling the same loopholes to the same people all over again. As long as Congress gets votes by selling favors, tax policy will cycle between simple and complicated, virtuous and corrupt.

Footnote: I’ve heard this story attributed to James Buchanan, but I don’t have any clear citation.

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