Of Public Interest

Volume 2, Number 5
May 2000

Tax Complexity and the Extractive Politics of Reform
by Richard E. Wagner

A Presidential election is coming close, and the candidates are busy competing on the basis of the reforms they promise to make. Thus we have promises to reform taxes, to reform education, to reform environmental regulation, and even to reform the finance of political campaigns. Do not all these promises of reform paint a strange scene? Does not the sight of politicians traveling through the country calling for reform make one wonder what politicians are doing when they are not campaigning? The systems about which they complain, after all, are their creation.

To be sure, each of them individually will say that the reforms they propose are needed to correct the mistakes of other politicians. Human nature being what it is, this is almost invariably the case. It is a rare politician who admits to being responsible for bringing us bad policies. Invariably, the bad policies are another politician=s doing. The reformer promises to fix the mistake. We can be sure, however, that when the next election comes, politicians will once again be shouting of the need for reform. Politics, it would seem, will always be giving us policies that need reform. Why is this so?

Why not, for instance, enact a good tax code, and then leave it alone for some time? In 1986 we actually had a tax reform that was widely heralded as a reform to end all reforms. Numerous exclusions and exemptions from the tax were eliminated. The base of the tax was broadened greatly, marginal tax rates were lowered, and the number of tax brackets was reduced to two, of 15 and 28 percent.

The very next year, however, this reform started to unravel. Since then, we have seen major reforms of the tax code in 1990, 1993, and 1997, and with less substantial changes taking place in the intervening years. Once again we are back to a highly complex tax code that seems naturally to evoke calls for reform. If the political enterprise is really so bad at generating policies that its products are continually defective and in need of reform, perhaps we should abolish the enterprise.

Or perhaps we misunderstand the true nature of the political enterprise. Perhaps we should expect tax politics to generate products that elicit continual calls for reform. Have you ever thought about how strange it is that the Senate Finance Committee and the House Ways and Means Committee are the most popular of committee assignments? These committees tell us how much tax we have to pay. Someone who buys us something will generally be more popular with us than someone who takes money from us. For this reason, it would seem as though legislators would fight for seats on the appropriations committees and struggle mightily to avoid being assigned to the revenue committees. Yet the opposite is true.

Suppose we had a simple, flat tax. After some initial level of tax exemption, everyone would pay, say, 15 percent of income in tax. The tax code would be simple, requiring only a few pages and not the 50,000 it now requires. Tax compliance would be easy, and would not require the huge supporting industry of lawyers, accountants, and software publishers that are now a part of our tax system. Members of the revenue committees, however, would not head the list of invitees to make presentations at conventions of trade associations. They would not receive hefty campaign support. Their ability to extract support from the American people for their political activities would decline markedly.

The ability of politicians to extract support depends heavily on their ability to practice tax discrimination through a continual fine tuning of the tax code. This fine tuning approach to tax discrimination makes the revenue committees highly desirable places to be, and at the same time it gives reform a continuing place on the public agenda. The ability to offer favorable tax treatment gives those politicians a position of prominence and influence that they would not possess under a nondiscriminatory tax system. It is the same for the ability to eliminate a favored tax provision or to impose a disliked provision.

In both instances, politics will be involved continually in making the tax code more complex. Consider the tax credit of $500 per child that was enacted in 1997. It could have been made universally available, but it wasn=t. Supporters of the measure must have concluded that greater political advantage could be secured by restricting the credit. This would allow the freed-up money to be used in other ways, where it would provide more political advantage. Hence the credit was limited to $1,000, and negative credits were disallowed. Phase outs were imposed, whereby the credit disappeared when income reaches $75,000 for a single parent and $110,000 for a couple.

The creation of the credit, as well as its complex structure, are all part of the political economics of tax policy, where politicians try to shift taxpayer=s money around in ways that give the most benefit to politicians and their supporters. The result invariably will be a complex tax code that will always evoke calls for reform. Yet genuine reform will never come so long as politicians are free to discriminate among taxpayers to whatever extent they choose, as limited only by a calculus of political support. Genuine reform would limit constitutionally the ability of politicians to employ tax discrimination as a tool for extracting political support.

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