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June 4, 2013
The Elements of Tax Reform
Joseph J. Thorndike

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Apparently, tax reform is a thing this year. At least that's what they say on Capitol Hill, where both taxwriting committees are hard at work on reform efforts. Many observers are pessimistic, but some have offered at least a thin ray of hope. "In recent weeks, the odds favoring tax reform in the not-too-distant future have improved somewhat," my Tax Notes colleague Bruce Bartlett wrote in a recent piece for The New York Times.

That sort of legislative handicapping is fun, but it's hardly more than speculation. Isn't there some way to bring more rigor, or at least analytical structure, to the parlor game?

History can help. Not in the sense of being predictive: As they say on Wall Street, past performance is not an indicator of future results. But past performance can sometimes shed light on the dynamics of change. And in doing so, it can make our guesses a little more educated. Or at least a little less random.

History serves that function in two ways. First, it can expand our notion of what's possible. We take a lot for granted in current policy discussions, including a range of boundaries and constraints. History reminds us that those constraints are not carved in stone, but are instead mutable and transitory.

But even as it broadens our horizons, history limits them, too. It can throw cold water on the hopeful aspirations of well-intentioned policymakers, reminding us that inertia -- including the political power of vested interests -- is hard and sometimes impossible to overcome.

Well-practiced history serves those roles simultaneously. It tells a story of change and continuity, integrating both in a single, complex story. That is the case with tax reform, where examining past episodes can explain why they succeeded and why they almost didn't. That information can help us assess the likelihood of current reform efforts.

Modeling History

Economists aren't the only ones with models -- historians have them, too. By identifying key dynamics and crucial players in the past, a model can help focus our attention. Building a useful model is not easy, especially if you're trying to do it from scratch. But scholars of U.S. tax history have a shortcut at hand: the model developed by W. Elliot Brownlee of the University of California, Santa Barbara. In a series of books and articles, Brownlee has outlined a model he calls "democratic statism," which seeks to explain historical changes to the tax system as a function of four variables: ideas, institutions, politics, and exigency.

Before exploring those variables in more depth, we have a threshold question to consider: What is tax reform, anyway? The term has meant different things at different times -- and to different people. Indeed, its normative connotations can make it seem like rhetorical window dressing -- tax reform describes the legislative changes we want, as opposed to the ones our opponents want.

But in the years since World War II, tax reform has developed a fairly specific, if not quite transcendent, meaning. In general, it has been used to describe a bargain of sorts: an expansion of the tax base in exchange for a reduction in statutory rates. Like most definitions, this one is not immutable. It reflects the intellectual hegemony of the Haig-Simons definition of income, which is hardly timeless or uncontested.

Still, most episodes of tax reform (or attempted reform) since the middle of the 20th century have embraced that trade-off as the essence of real reform. That embrace has derived not only from the intellectual dominance of Haig-Simons (which put base broadening at the center of the policy debate), but also from a durable legacy of wartime taxation: relatively high statutory rates (which made rate cuts broadly popular).

Much has changed since the first generation of postwar tax reformers began to articulate the base/rate policy bargain. Among other things, statutory rates are much lower, thanks partly to successful episodes of tax reform and partly to other episodes of unbridled tax reduction. The larger fiscal context has also changed, as the "era of easy finance" (to use C. Eugene Steuerle's term) has given way to the age of fiscal constraint. But the base/rate trade-off still remains at the heart of our modern understanding of tax reform, at least as the term is understood by most policy experts.

A related definitional issue concerns the scope of tax reform. Presumably, small-bore revisions to the tax system don't constitute tax reform as usually understood -- even if those reforms serve the base/rate bargain. To be called tax reform, legislative initiatives must be suitably ambitious.

Tax reform, however, is conceptually distinct from a really ambitious revision of the revenue structure, sometimes called tax replacement. In his historical work, Brownlee has described that sort of change in terms of tax regimes -- revenue systems with their own "characteristic tax base, rate structure, administration apparatus, and social purpose." The shift from one regime to the next is fundamental, with clear lines of demarcation separating old from new.

By contrast, tax reform is more incremental. Tax reform is best used to describe a reasonably cohesive set of legislative provisions that extend the viability of a tax regime by fixing some of its more obvious flaws. Tax reform does not change the regime itself. Indeed, that is not its purpose. Tax reform is a repair, not a replacement. Sometimes it can rise to the level of truly ambitious repair, perhaps even to wholesale renovation. But tax reform leaves the basic structure of a revenue system recognizable from start to finish.

Applying that definition to the postwar period, we can identify several episodes that might reasonably lay claim to the mantle of tax reform, including laws enacted in 1969, 1976, and 1986. Some might include 1954 in this list, and a variety of smaller-scale revenue acts might also fit the bill. But the first three seem the most obvious.

Democratic statism can help us understand how those episodes played out and why they succeeded. Brownlee uses his model to explain the shift between tax regimes, but it can also enrich our understanding of less dramatic episodes in tax lawmaking; the same variables that conspire to force a regime change (once in a blue moon) can also shape more modest episodes of tax reform (slightly more often). Let's consider them.

Ideas: Democratic statism makes plenty of room for ideas, granting them an important and independent role in the policy process. Indeed, they are the connective tissue of tax reform, linking experts, politicians, and voters in a common project. Under the rubric of ideas, we can find large, aspirational, and sometimes highly rhetorical plans. But we can also find more detailed, technical, and practical plans for legislative revision of the tax laws. In other words, the notion of ideas might be used to describe Robert Hall and Alvin Rabushka's The Flat Tax, but also the Treasury Department's 1984 classic, "Tax Reform for Fairness, Simplicity, and Economic Growth."

Institutions: Governmental institutions play a pivotal and independent role in the policy process, distinct from the raw politics of Washington. Institutions, which include some elements of the federal bureaucracy, often wield their power through expertise, as Treasury did in the early 1980s, for instance. Indeed, while institutions shape the policy process in many ways, they often make their most obvious contributions through the generation and articulation of ideas. Also, however, many institutions play both formal and informal roles in the policy process. Congressional committees and their leadership, for instance, can be crucial to the success of tax reform.

Politics: Obviously, institutions live in a political world, and democratic statism makes room for that reality. In addition to the activities and personalities of elected politicians, it gives a powerful role to the operation of nongovernmental forces, including lobbyists, special interests, and voters (the last usually mediated through opinion polls). Under the category of politics, you might find grass-roots lobbying movements, as well as partisan jockeying on Capitol Hill. But the key factor here is often pressure from outside government -- the demand for change from constituents of one sort or another.

Historical contingency: Policymaking requires a catalyst. When it comes to tax reform, as with most other kinds of political action, change happens when it must, not when it should. Sometimes lawmakers will move ahead with change of their own volition; arguably, that's what happened during the 1986 tax reform. But more typically, changes to the tax system come about when some external factor forces change -- a major revenue shortfall, for instance, as often occurs during the early stages of a war.

Those four variables are not entirely distinct from one another. Indeed, they are deeply intertwined. But they provide an analytical framework that might allow us to gauge the prospects for tax reform -- at least, that is, if we can first discern how the variables have operated in the past.