Reforming the Tax Code

 

The federal tax code hasn't been seriously tweaked since 1986, when President Ronald Reagan and House Democrats cut personal taxes, and closed many loopholes. Now, both sides say they are open to comprehensive reform—even as they disagree on whether it should raise revenue or not.

But economists and tax experts have their own ideas on what could improve the system—even if they don’t have a chance to pass in Congress. Deductions are for medical savings accounts, and college expenses are very popular and unlikely to be eliminated. 

“They don’t do as much good for as many people as intended,” says Charlotte Crane, a Northwestern University law professor who specializes in tax policy.

Crane says the deductions should go.

“They create a lot of administrative headaches for everybody," she said.

Even more unlikely is a plan to completely eliminate tax deductions—for charitable donations, mortgage interest, you name it. That’s the only way to avoid the complicated, deduction-heavy system we have now, says University of Chicago finance and entrepreneurship professor Luigi Zingales.

“I know this is extremely painful,” he says, “but when you open the door for one deduction, you don’t know when to stop. Then everyone lobbies for more deductions. I want a law to say you can’t have any deductions, so people won’t even ask for them.”

Discussions in Washington have focused around lowering corporate tax rates and closing loopholes. Instead of just lowering corporate rates (at 35 percent for the wealthiest companies), Zingales would swap the corporate rate with the personal tax rate on capital gains, increased to 20 percent in the fiscal cliff negotiations.

“This takes away the incentive to play games, and it’s revenue neutral when both taken together,” he says. “Corporations are much more effective at finding loopholes than individuals. They can also lobby to create special loopholes. So at 35 percent, it’s an incentive to lobby aggressively [that can be taken away].”

But as to what could actually pass this spring? Crane has doubts about even minimal changes. One of the most important issues is the “cross-border corporate problem,” says Crane, or companies taking profits abroad to avoid high U.S. taxes.

“That remains something that has no agreement on what reform would look like,” she says.