Web Chat: The Future of Tax Reform

Each year as millions of Americans race against the clock to complete their taxes by mid-April, the debate over when and how the nation’s tax code should be reformed garners renewed interest. While most agree that the system is complex and outdated, there is little consensus over how it might be simplified or what changes are most urgent.

On April 11, Robert Pozen answered your questions on reforming the nation’s tax code during a live web chat moderated by Vivyan Tran of POLITICO.

12:30 Vivyan Tran: Welcome everyone, let’s get started!

12:30 Comment From Anne: Why has our tax system become so complicated? It seems as though there are so many loopholes and exemptions that no one really knows quite how the entire thing works.

12:31 Robert Pozen: Our tax system is so complex because over the years Congress has added many special provisions and exemptions in response to pressures from various groups, often in the form of political compromises that are vague.

12:32 Comment From Christopher: President Obama seems to be making the Buffett rule a key part of his 2012 stump speech. But would it really do that much to help the country? I’ve read that it would only pull in a few hundred million when all is said and done.

12:34 Robert Pozen: The Buffet rule for millionaires seems to be an important part of the President’s political program; he believes this is important as a matter of tax fairness. However, economically, that tax would have a minimal effect — it would raise only $47 billion over the next decade — a drop in the federal budget.

12:34 Comment From Reid: What needs to happen to make comprehensive tax reform a reality in the United States? Or are there just too many vested interests lobbying against it?

12:36 Robert Pozen: Because of all the vested interests, comprehensive tax reform will happen only when Congress is faced with a crisis. This may happen at the end of 2012 when the Bush tax cuts expire and sequestration on the spending side kicks in — unless Congress does something dramatic. So maybe Congress will do something dramatic then.

12:36 Comment From Alexis, DC: Do you see comprehensive tax reform coming anytime in the near future?

12:37 Robert Pozen: As I said in the answer to the above question, there is a chance for major tax reform at the end of 2012 because if Congress does nothing, we will be taking $1 trillion out of the economy and that would likely cause a recession. Of course, Congress could avoid that result by piecemeal reform. But there is at least a chance for a big-bang approach to tax reform in late 2012 or early 2013.

12:38 Comment From Gianne: Is a VAT tax a viable solution for the US?

12:41 Robert Pozen: A VAT is essentially a national sales tax, as they have in Europe. It has a lot of advantages from a policy perspective since it taxes consumption and implicitly promotes investment. It also can be refunded at the border to promote exports.

However, Congress is unlikely to pass a VAT for three reasons. First, it would involve a radical change in our whole tax system — for example, it would change the way all retirement plans are treated. Second, Democrats fear that a VAT would be regressive because the poor consume a much higher portion of their income than the rich. Third, Republicans fear that a VAT would raise too much tax revenue for the government spend. The VAT started at 3% in Europe but now has risen in many countries above 15%.

12:41 Comment From Tim: Is America’s global competitiveness threatened by our outdated corporate tax structure?

12:45 Robert Pozen: Our taxation of foreign profits of US corporations is counterproductive. If they keep those profits abroad, they pay no US taxes on those profits. But if they bring them back to the US, they pay a 35% rate — as compared to an effective rate of 20% in most of our major trading partners. Thus, our tax system discourages US corporations from using their foreign profits to build facilities or make acquisitions or pay dividends in the US. That is why US corporations have almost $2 trillion in foreign profits sitting in foreign bank accounts. We need to enact a totally different system for foreign profits of US companies. I have suggested that there be a minimum tax imposed on all such profits in the range of 16 or 17% per year. That would encourage US corporations to use their foreign profits in the US and would also raise tax revenues in the US.

12:45 Comment From Kat: Rep. Paul Ryan is calling for tax reform in 2013. Any chance of this actually happening?

12:48 Robert Pozen: Paul Ryan is calling for substantial reductions in corporate and individual tax rates, and suggests that the lost revenues would be made up by closing tax loopholes and special exemptions. However, Ryan has not specified what loopholes or exemptions he would eliminate. In fact, he would have to take on some pretty powerful lobbies to get to a flatter tax — with a relatively low rate and few exemptions. For example, he would have to limit the deduction on mortgage interest, which now applies to second homes and home equity loans. It is unclear if Congress would be able to do the heavy lifting needed to get to such a flat tax.

12:49 Comment From Peter M: What economic impact does a nation’s tax code ultimately have?

12:51 Robert Pozen: We have a tax code with a relatively high rate and lots of exemptions and deductions — which tend to serve powerful political interests. This system has a negative impact on our economy because it tends to allocate too many resources toward those areas with the most exemptions — for example, like ethanol or solar energy — rather than going to the most economically viable activities. We would be better off with lower rates applicable to all businesses, so that the most economically viable ones would flourish. But this requires the political will to eliminate many of these exemptions and tax subsidies.

12:51 Comment From George T: If you were advising the next administration, what reforms would you like to see made to the corporate and personal tax structures?

12:55 Robert Pozen: On the personal front, I would like to see lower rates combined with an overall limit on deductions that can be taken along the lines suggested by Harvard Professor Martin Feldstein. That could be done on a revenue neutral basis, and would be easier to achieve than taking on each deduction individually since each has such a strong political base.

On the corporate side, again I would like to see a lower rate with fewer special exemptions and deductions. But Congress has to be willing to limit those and that is politically difficult. Also, as explained above, we need to have a major reform of the way we take foreign earnings of US corporations. That would encourage them to use their foreign earnings in the US and raise tax revenue for the US Treasury.

12:56 Comment From Stephanie T: With America’s deficit reaching new levels every day, is tax reform a solution everyone could agree on? If we just tax individuals more effectively, can’t we help restore the nation’s fiscal health?

1:01 Robert Pozen: To keep the US deficit roughly at its current level relative to GDP over the decade, we need to reduce spending or increase taxes by roughly $4 trillion. This cannot be done reasonably just by raising taxes. Even if Congress were to pass the Buffett tax on millionaires and raise rates on those with annual income of over $250,000, that would get us at most one-third of the way. So we need to combine tax reform with reductions in government spending. It is unclear if we have the ability to cut much more from the defense budget — which has already been cut by close to $500 billion over the next decade. Reductions in the growth of health care spending are obviously needed, but very hard to agree upon. Therefore, we might most fruitfully look to slow down the growth of Social Security benefits in a progressive way — with protections for lower-wage earners and slowdowns for higher-wage earners. This approach is often called progressive indexing.

1:01 Vivyan Tran: Thanks for the questions everyone, see you next week!