THE BLOG

Tax Reform Is Irrelevant

01/02/2013 12:38 pm ET | Updated Mar 04, 2013

No issue with less potential impact on public good gets more attention than tax reform. It is possible to argue that the amount of taxes collected from the public impacts the national economy, but there's no compelling evidence suggesting that the mechanism used (income tax vs, value-added tax vs. personal property tax) makes much difference.

We're now enjoying the latest iteration of a silly and endless debate on the latter point. It assumes that somehow collecting the same amount of taxes we do now but in a different way (say by eliminating or capping some deductions to fund a reduction in rates) would a difference. That's an interesting theory. When rates were lowered and deductions limited in 1986, there was no resulting burst of economic growth. Nor was there any clear behavioral change (credit card debt didn't decline when it lost its tax deductible status and prices of mansions didn't change when the tax subsidy for rich buyers was nearly halved).

In fact, tax reform involves quest for two impossible dreams. On a macro level, there's a hope that a better system would lead to substantially greater economic growth that would benefit us all. From a personal perspective, there's the dream that my tax rate would be cut while retaining the tax benefits I now receive. Renters root for the demise of the mortgage interest deduction. And reforms that eliminated the deduction for state and local taxes would benefit those in low-tax states, particularly those lacking state income taxes, while putting residents of states with relatively high marginal rates -- like California, New York and the District of Columbia -- at a disadvantage.

It is a heavy lift to suggest somehow that the aggregate impact of tax reform would be positive. And it is hard to imagine that the high-tax states would slim down in response. It is prudent to predict they would fight hard to retain the deduction, which a coalition led by Gov. Mario Cuomo did successfully in 1986.

But from a broader perspective, it is instructive to look at how the states tax and the impact on charitable giving. In Hawaii the top income tax rate is 11 percent, which means that a contribution of $1000 has a net cost to the donor of only $890. There 1.7 percent of adjusted gross income is donated to charity. But in Florida, which has no state income tax, donations equal 2 percent of AGI despite the fact that donors lose a full $1 for each dollar donated.

Which raises the question of why the charities lobby is so strongly fighting proposals to limit the deductibility of contributions.

If reforming the tax system wouldn't make any difference, what's the aim of those who invest so much time in the debate. When offered to voters, it can be sold as a lottery where everyone is a potential winner. Among rich people with large tax bills, it provides a chance to shift the burden from one subgroup to another. That's easier done in a big, complex bill with many moving parts than in legislation that directly suggests the shift. Such camouflage can be especially helpful in changing the distribution between different types of taxes (income vs. use) or different payors (individuals or corporations).

Of course there is always the possibility that the new system will yield a bit more revenue, an outcome that would ease today's fiscal stress while dodging the political blowback of an overt tax increase.

There's also a marginal positive impact in streamlining the tax code and stripping away from the barnacles that inevitably accrue over time. That's why today's tax law is significantly bulkier than the 1986 act.

A case can be made that tax reform is the opiate of the people and their elected representatives -- a compelling topic that diverts them from the real issues like collecting adequate taxes to pay for the government services we rely on. It's a enduring entertainment that has bipartisan support and allows us to continue dodging the really tough questions.

More Jaffe economic commentary is posted at Punditwire.com