In recent years, developments in tax policy, and political economy more generally, have been dominated by two themes: rafts of new technical rules of great import to practitioners or affected taxpayers, but no one else, and legislative paralysis. The past year fits squarely into this modern tradition.
Low points in 2012 are easy to find, thanks to the Presidential election and the ideological fixations of the contemporary Republican party. The most important for policy, which resonates in the current budget negotiations, is the consistent overstatement of the negative consequences to economic growth of moderate increases in tax rates, in particular as applied to “small business.” These systematic overstatements come from two directions. First, proponents routinely (and at this point, knowingly) mischaracterize much salary or investment income as “small business” income, notwithstanding the publication of a major study by the US Treasury that for the first time gives reliable data on how much income appearing on individual tax returns actually comes from genuine small businesses (about 10 percent of total income in the top two tax brackets, as it happens). Second, proponents of the sky is falling worldview claim strong causal relationships between top tax rates and growth that are just not evident in straightforward studies of their historical paths — as the Congressional Research Service showed in a report first published earlier in 2012, which then was retracted under mysterious circumstances redolent of political pressure, only to be republished last week with its conclusions essentially unchanged.
Another election-related low point was the refusal by Governor Romney to release more than one year of past tax returns (2011 of course was the current year's return); this was inconsistent with the tradition established by Governor Romney's own father, and, particularly in light of the extraordinarily low effective tax rate that Governor Romney enjoyed in 2010 and 2011, and numerous questions surrounding his tax planning, was very troubling for the modern tradition of fiscal transparency between candidates and voters. This transparency explains why we have not suffered a significant tax scandal involving a nominee or sitting president since President Richard Nixon's abuse of the tax code.More fundamentally, disclosure goes to the heart of the truthfulness with which a nominee engages the American people, and it assures us that he in fact has comported himself before the election with the high moral character we associate with a future president.
A final example, but least a colorful one, was Herman Cain's 9-9-9 plan, which as I showed in a paper published in late 2011, would have materially raised the tax burden on many low- and middle-income taxpayers. Its net effect would have been to skew downwards the distribution of tax burdens, compared with current law. Its proponent of course failed to become the Republican candidate for President, but it is not clear whether the electorate ever appreciated who would actually bear the cost of his catchy slogan.
Nonetheless, there have been at least two positive developments of general importance. First, in June the Supreme Court held that the individual mandate at the heart of the Affordable Care Act was a constitutionally valid exercise by Congress of its taxing power, even though the mandate was not within the powers granted by the Commerce Clause of the Constitution. This rationale surprised many observers, but Chief Justice Roberts and the majority plainly got this right. The reason this case was difficult for many observers to parse is that Congress (that is, Democratic leadership) wanted to eat its cake and have it too. The legislation could have been, and in an earlier draft essentially was, presented more clearly and cogently as a new income tax on all of us (subject to various exemptions and limitations, just like any income tax), with a twist: you could claim a tax credit (a dollar-for-dollar offset against your tentative tax bill) if you purchased qualifying private insurance. Since the tax itself could be seen as funding some of government's costs of providing medical care for the uninsured, the tax-and-credit mechanism makes good logical sense: it prevents what otherwise would be effective double taxation — once when you pay the tax, and once when you buy private insurance that duplicates to some extent the minimal coverage of the government emergency care safety net. This is all that the individual mandate does. Stripped of labels, the only “mandate” is to pay your tax bill. That really is the base case. Most of us will be exempted from any new tax charge, because we will claim our notional tax credit for the value of our private insurance, but the fact that cash tax collections will come only from a minority of us does not make this any less a tax. (For those who want to read more on this, I previously covered the topic in a short article (Kleinbard, Constitutional Kreplach, 128 Tax Notes 755 (Aug. 16, 2010).)
What is really important about the Supreme Court's decision is that it serves as an implicit reminder of how very broad Congress's taxing power is. Basically, Congress can spend money any way it sees fit to advance our collective “general welfare,” so long as in doing so it does not violate some fundamental individual right or express prohibition contained elsewhere in the Constitution (for example, by funding a national church). And Congress in turn has the plenary power to raise taxes to pay for that spending, subject only to really trivial limitations (like not taxing exports). For example, Congress would not need to rely on the Commerce Clause to create a genuine national healthcare program — it need only determine that spending money on healthcare advances the general welfare, and then Congress is free to raise the taxes required to fund that program. That after all is the constitutional basis for Medicare.
The second positive development actually was introduced into policy debates by Governor Romney in the run-up to the election: that is the sudden focus on tax expenditures, and in particular on personal itemized deductions, as highly distortive, poorly targeted and frankly unaffordable subsidies. Curbing them in one fashion or another would yield very substantial revenues without raising marginal rates, and in general would add to the overall progressivity of the tax code. (As it happens, I believe that there is a much more convincing case for converting these deductions into a 15 percent tax credit than for capping them as a fraction of a taxpayer's income, as urged for example by Martin Feldstein.) This does not mean that limiting personal itemized deductions is a fair substitute for raising the top two marginal tax rates, as the latter is still more progressive and in keeping both with historical and with world norms. But when the time comes for any sort of tax reform, limiting personal itemized deductions must be on the table. As I wrote over two years ago, the personal itemized deductions may be tax sacred cows, but at this point either we choose to corral them, or they will stampede over us.