As Americans ponder the prospect of tax reform, it seems only natural to look for precedent. What can we learn from the history of American taxation? More specifically, what lessons can we distill from the most important postwar experiment in federal tax revision, the Tax Reform Act of 1986?
"History repeats itself," observed British author Philip Guedalla, "Historians repeat each other." He had it half right: Historians have a penchant for repetition. But history itself is not much for reruns. As they say on Wall Street, past performance is no indication of future results.
Having dispensed with that caveat, let me offer three observations. First, tax reform tends to put a premium on expertise and ideas. Second, big changes can arrive in small packages. And third, partisan wrangling can be a good thing.
Ideas and Experts
For most of the 20th century, experts played a central role in the development of American federal tax policy. As early as World War I, lawyers, economists, and accountants helped shape the modern revenue system. In cooperation with political leaders, they transformed the income tax from a fiscal appendage to a revenue workhorse.
As the income tax matured, so did the policy community surrounding it. Originally designed as a tool for taxing the rich, the tax became a means to finance the modern state. World War II made the levy a pillar of national security, and the postwar growth of American government drew sustenance from the mass tax introduced in the early 1940s.
Tax experts were the stewards of this fiscal transformation, guiding lawmakers through the treacherous tax debates of the early postwar era. They embraced the new, broad-based levy, recasting this rich man's burden as a bipartisan tool for modern governance. At the same time, they became the nation's fiscal conscience, railing against the political penchant for tax preferences. Luminaries like Stanley Surrey, Joseph Pechman, and their colleagues in the tax intelligentsia urged lawmakers to impose moderate rates on a comprehensive base.
Predictably, political dynamics continued to erode the tax base, expert opinions notwithstanding. Lawmakers indulged their taste for deductions, exemptions, and credits, leaving the tax base riddled with loopholes. By the 1970s, a growing sense of crisis surrounded the tax system, even creeping into the political mainstream. President Jimmy Carter made a half-hearted stab at reform, and Treasury officials released a sweeping study of the most likely options; Blueprints for Basic Tax Reform (2nd ed., Tax Analysts, 1984) became a touchstone for later debate, guiding officials as they struggled to design a principled, yet pragmatic, agenda for reform.
Ronald Reagan's election seemed to close the door on fundamental tax revision -- even as it paved the way for sweeping tax reduction. But by 1984, Reagan showed new interest in the subject, especially when reform could be recast as simplification. The Treasury Department assumed center stage as the White House pressed the case for ambitious restructuring of the federal tax system.
Indeed, what seems striking about the tax debate of the mid- 1980s is the latitude given to Treasury officials. While highly attuned to political reality, Treasury specialists were allowed to develop a tax agenda that gored any number of sacred cows. Ideas were allowed to develop within the fiscal bureaucracy, shielded from the pressure of political expedience. By the time the Treasury tax agenda made its way to Capitol Hill, it had substantial momentum. Perhaps even more important, it had been defined in ambitious terms that helped pave the way for dramatic reform.
By contrast, today's reform initiative seems to be developing from the outside in, with politics shaping ideas during this early formative stage. The Treasury Department is notably absent from the effort, hobbled by important personnel vacancies. Indeed, Treasury seems to have been relegated to a supporting role in this current fiscal drama.
Moreover, the administration's tax reform panel seems hemmed in by a modest mandate. President Bush told panel members that they must recognize "the importance of homeownership and charity in American society." He also directed that at least one of the panel's final proposals take the income tax itself as a starting point for reform; wholesale tax replacement could not be the only option.
In one sense, those constraints simply reflect political reality. Given the incremental nature of most tax reform, it seems only prudent to assume that income taxes will remain a pillar of federal finance. And since deductions for mortgage interest and charitable contributions enjoy broad support, we might as well keep them in the mix, too.
But that's the sort of thinking that can lead to less thinking, not more. If we take so much for granted, then what sort of change are we likely to get? Something grand and dramatic? Or just a little tinkering around the edges?
The Scope of Reform
We might do well to dispense with those dichotomies. In fact, big things can come in small packages.
When it comes to tax history, scholars tend to divide into two camps, one stressing change, the other continuity. Incrementalists believe that tax reform develops in small steps. Ambitious agendas tend to falter in the political process, ensuring that most successful changes will be discrete matters of degree, not character.
In his noted study of federal taxation, the political scientist John Witte even described the fiscal watershed of World War II as "a series of incremental adjustments to existing policies." Perhaps. But that's like telling the man at the end of a gangplank that his next step is just like any other: Some increments are more important than others. The exemption cuts of World War II totaled just $500 for individuals, but they transformed the nature of the American state and society. Similarly, wartime rate changes, while often simply a matter of adjusting numbers in a table, were enormously important to the taxpayers who found themselves paying marginal rates exceeding 90 percent.
But Witte was certainly right when he suggested that most tax reforms are modest in scope. While national emergency tends to encourage wholesale reform, peacetime revision is much more modest. Even the Tax Reform Act of 1986 was essentially incremental, a return to first principles. Specialists and lawmakers set out to reform the income tax, not replace it.
But saying that a change is incremental is not the same as saying that it's unimportant. Incremental changes can add up over time. And when many incremental changes are enacted together, they can equal more than the sum of their parts. That was certainly the case in 1986. While not quite a watershed in the history of American taxation, it came very close. Unlike a true watershed, however, it proved vulnerable to piecemeal erosion. Tax regimes are built on necessity, not good intentions. The mass income tax established in World War II was a necessity of modern government, hence its durability. The tax reforms of 1986 were a question of choice and political expedience, hence their undoing.
In fact, incremental change can still be important. Some small changes are really just the thin edge of the wedge. The income tax introduced in 1913 was that sort of change; fiscally insignificant at first, it soon vaulted to the pinnacle of federal finance. When the camel sticks his nose under the tent, there is often more to follow.
In the current tax debate, that metaphor seems most apt in describing plans for new tax-advantaged savings accounts. The Bush administration has long championed those accounts. Should they make their way into the next tax reform law, we will have taken another long stride down the road to a consumption tax. The accounts are part of the "five easy pieces" strategy for gradual but dramatic tax reform put forth by the Washington-based Committee for Strategic Policy Reform. Advocates of consumption taxation may be onto something, harnessing the incremental nature of peacetime tax reform to a much grander policy agenda.
The Importance of Partisan Politics
When it comes to tax reform, it's easy to chastise politicians for being so political. All too often, tax debates devolve into name calling and mindless bickering.
But every once in a while, partisan wrangling can lead to happy results. In 1986 Democrats and Republicans wrestled for the mantle of principled tax reform. As the historian W. Elliot Brownlee has observed, the Reagan administration and congressional Democrats "edged into a competitive scramble to occupy the high ground of equity-driven tax reform."
Just a few years earlier, those same political leaders had engaged in a similar scramble to cut taxes, bidding up the cost of Reagan's 1981 tax reduction legislation. By 1984 the fiscal bill for that orgy of self-indulgence had already come due, forcing a series of tax increases. And when Congress finally turned to revenue-neutral tax reform, partisan competition took an unlikely turn.
Today, we don't see much partisan debate around tax reform. The White House has moved taxes to the back burner, focusing instead on Bush's troubled plan to overhaul Social Security. Handpicked witnesses before the tax reform panel seem more interested in lowering expectations than suggesting ideas.
Most striking, Democrats have been largely silent when it comes to tax issues. Cowed by Bush's popularity and the defeat of Sen. John F. Kerry, D-Mass., they seem to have ceded the field. Recently, the liberal Center for American Progress offered a comprehensive agenda for progressive tax reform. But their statement was like a voice in the wilderness. Where are the Democrats on that issue? Their absence bodes poorly for the future of principled tax reform.