A History of Failure

If tax reform is deficit neutral, i.e., it neither adds to nor subtracts from the national debt, the benefits for the winners will be equal to the costs for the losers. Collectively speaking, deficit-neutral tax reform can still be a net benefit to society, as a simpler and more efficient tax code increases productivity and thus growth. The challenge, however, is overcoming the objections of the individual factions that are going to see their tax bills increased. History suggests just how difficult a task this is.

The push for tax reform started shortly after Congress stopped using the code solely as a source of revenue, and instead as a tool for economic and social engineering. The first major “engineered” tax law was the Tariff of 1816. One of its central purposes was to protect (mostly Northern) industries deemed essential to national security. However, within a decade, Southern planters, whose interests were harmed by industrial protection, were decrying the tariff as an unconstitutional breach of governmental authority.

Ever since then, there has been a cyclical pattern: Congress creates tax legislation designed for some defensible purpose (growing the economy, promoting homeownership, stimulating industry, etc.); over time, these laws accumulate, creating needless complexity and unfairness; Congress tries, and usually fails, to fix this problem of its own creation.

After the Civil War, the tariff became a massive logroll that ensnared capitalists, industrial workers, Midwestern farmers, and even Union veterans—largely for the maintenance of the Republican coalition between the Civil War and the Great Depression. The tariff regime was so corrupt and inequitable that progressive reformers successfully implemented an income tax, going so far as to get a new constitutional amendment ratified in 1913. Yet just as soon as Congress acquired the power to tax income, it started playing the same old game. And the first calls for income-tax reform came in the 1920s.

All in all, income taxes were a modest source of revenue until World War II, when the government increased rates and created a broad base. That increased opportunities for tinkering with the tax code in all sorts of ways.

In particular, Congress likes to make use of “tax expenditures,” which are basically spending programs within the tax code via exemptions or credits for special groups. These can be need-based (for example, the earned-income tax credit), equity-based (the state and local tax deduction), group-based (excluding GI Bill benefits from taxation), generalized economic incentives (the treatment of capital gains), or specialized economic incentives (depletion allowances for the oil industry).

Whatever the merits of any particular exemption when it is first enacted, these credits tend to create problems over time. They accumulate, making the schedule overly complex (which itself creates inequality, as wealthier individuals or firms can afford tax specialists who secure a lower effective rate). They become outmoded, as business practices or economic priorities change. They can also compound with other exemptions or credits, creating accidental tax havens.

The problem with fixing these issues is similar to the problem of cutting spending: Even if the sum total is bad for the country, somebody, somewhere, benefits from each particular item and usually has allies in government who are looking out for his interests.

The Tax Reform Act of 1986 is the exception that proves the rule. Congress successfully streamlined the tax code that year, but it required an extremely rare confluence of factors.

First, the tax cuts of the early 1980s benefited some industries more than others. Changes made in 1981 interacted with some Kennedy-era laws to create opportunities for massive tax shelters, especially for capital-intensive firms like General Electric. This, in turn, created a coalition of “losers”—businesses that could not benefit from these shelters—who put pressure on Congress to create a more equitable playing field.

Second, the public had a heightened awareness of this inequity, thanks to the rapid increase in the budget deficit following the 1981 tax cuts. Many big corporations were paying little to nothing in income taxes, even as their stock prices rose. This rubbed many Americans the wrong way, putting pressure on government to reform the system.

Third, both parties were more or less committed to tax reform. Early in his presidency, Ronald Reagan had been opposed to closing tax loopholes, figuring this was the same as raising taxes. But, anticipating that Democrats were going to run on tax reform in the 1984 election, he shifted his views. By 1986, both sides were ready to deal.

And even then, the big reform could very well have fallen apart. Lobbyists descended on Capitol Hill in an effort to secure privileges for their employers. As Jeff Birnbaum and Alan Murray recalled in Showdown at Gucci Gulch, their classic account of the 1986 tax reform, “The amount of time, money, and effort expended on tax lobbying throughout 1985 and 1986 was enough to overwhelm even the most cynical congressional observer.” Even though Congress did streamline the code, one analysis from the Philadelphia Inquirer found over 650 exemptions still in the law, mostly written in a legalistic way that hid the identity of the beneficiaries.

The political situation in 2017 is less fortuitous than it was in 1986. There is no coalition of industry groups complaining about how they are being treated; there is little public clamor for fundamental reform; and there is no bipartisan agreement.

None of this is to say that tax reform cannot happen. Only that it is incredibly difficult. Our tax code is collectively inefficient and unfair, but each line in it was written for a reason. Each provision benefits some faction or company, which will fight tooth and nail to retain it. Overcoming this collective action dilemma has stymied generations of lawmakers. Why should this one be different?

Jay Cost is a contributing editor to THE WEEKLY STANDARD.