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Are Democrats And Republicans Closer On Taxes Than They Let On?

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"Deductions (e.g., mortgage interest, charity), exemptions, and credits (especially as they are phased out) create different effective tax rates on different activities," explains Douglas Holtz-Eakin, president of the conservative American Action Forum.

"It costs less than a dollar to give a dollar to charity because the government kicks in a fraction (say 35%) of that cost in the form of lower taxes. A tax code littered with these kinds of provisions ... pushes people to low-value activities," Holtz-Eakin says. "If I wouldn't have given $1000 to charity in the absence of the tax provision, but I do when there is a deduction, I'm shifting my dollars on purely tax basis. Since we presume people do those things that are valuable to them, this represents lower-value activity. ... You want your economy maximizing its value to households; all those special provisions mess this up."

The flip side to this is that the deductions are effectively financed by higher income tax rates, which economists believe dampens productivity.

"No serious economist actually believes cuts in current rates could increase revenue," explained University of Michigan economists Betsey Stevenson and Justin Wolfers in a recent op-ed, dispelling a common supply-side economics myth. "[B]ut most agree that a reduction in the marginal tax burden increases the incentive to work."

But that's the easy part -- who doesn't want to pay less income tax? Tax simplification would be much easier if the distorting preferences in the code weren't also very popular.

"Consider the deduction for mortgage interest," conservative Harvard economist and Romney adviser Greg Mankiw wrote in a New York Times op-ed. "The policy is politically popular, but economists have long thought it has little justification. Because of this provision, among others, our tax system gives a better treatment to residential capital than it does to corporate capital. As a result, too much of the nation's saving ends up in the form of housing rather than in business investment, where it could have increased productivity and wages. This efficiency cost might be worth bearing if the deduction had a benefit from the standpoint of equality, but it fails there as well."

Not all economists buy into the substantive consensus, or believe an excessive focus on simplification is strategically wise.

"As you may know, I'm skeptical of the broaden-the-base-lower-the-rates mantra, because I really worry we'll end up with a lot of the latter and a little, if any, of the former," said Jared Bernstein, an economist at the liberal leaning Center on Budget and Policy Priorities, and former economic adviser to Vice President Joe Biden.

But he understands why the view is widely shared. "[T]he main impetus behind all of this is simple and compelling. The more that's left out of the base, the greater the incentive to define your income as a type that's exempted from taxation," Bernstein told TPM in an email. "Economists view taxes on most sources of income to have 'deadweight losses' because they discourage work and saving and thus lower pretax income and growth. So a simpler broader base with lower rates is optimal in this regard."

Bernstein doesn't fully buy the latter half of the argument. "You have to factor in the benefits side of the equation--the public goods we pay for with tax revenue and the extent to which they offset any losses. Clearly, an educated workforce and productive public infrastructure are good examples of what's left out of the simple reasoning. Equally important, recent literature on taxation in the US has suggested that our income and capital tax rates are way below the range where large distortions that would make most of us worse off would kick in."

And as questions of tax rates, benefits, and revenue get more specific, the disagreements grow wider -- in part for ideological reasons.

For instance, Bernstein and Holtz-Eakin disagree about the importance of taxing investment income.

"All [reform proposals] have low rates, broad base," says Holtz-Eakin. "The major difference is whether your tax the return to saving (interest, dividends, capital gains) as heavily (or at all) as the tax on wages. My reading of the literature is that the tax on saving should be low (or zero), which would enhance growth."

"My main change toward simplification would be not to give preferential treatment to capital incomes," Bernstein said by contrast. "Otherwise, I thought the economy and the budget did well in the Clinton years, with basically the same system we have now but with higher marginal rates."

But it's complicated much further by the fact that the politics become more tangled the deeper into the weeds you go.

About The Author

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Brian Beutler is TPM's senior congressional reporter. Since 2009, he's led coverage of health care reform, Wall Street reform, taxes, the GOP budget, the government shutdown fight and the debt limit fight. He can be reached at brian@talkingpointsmemo.com