“Blank Slate” Approach to Tax Reform Leaves Biggest Question Unanswered

Yesterday’s call from Senate Finance Committee Chairman Max Baucus and ranking Republican Orrin Hatch to initiate tax reform with a “blank slate” that doesn’t include any of the deductions, credits, exclusions, and other tax breaks collectively known as “tax expenditures” leaves a critical question unresolved:  what will policymakers do with the proceeds from narrowing or eliminating tax expenditures?

Will they use a substantial share of the savings to help put together an alternative to sequestration or otherwise devote such savings (presumably in conjunction with spending reductions) to the long-term deficit reduction that the nation needs?  Or will the savings go entirely to cutting tax rates?

Using some of the savings as part of a responsible, balanced alternative to sequestration —thereby averting harsh cuts in areas ranging from national security to education, medical research, and Head Start — and to help put the nation on a firmer long-term fiscal footing ought to be a higher priority than the pursuit of ever-lower tax rates.

Tax reform that curbs unproductive tax expenditures surely has merit.  Yet revenue-neutral tax reform would be highly problematic, as it would likely take revenues off the table for deficit reduction for years to come by using up virtually all politically achievable reductions in tax expenditures.  That, in turn, would likely take mandatory programs off the table for deficit reduction as well, because many policymakers would justifiably reject large mandatory cuts in the absence of new revenues.

In addition, policymakers face an immediate need to replace the harmful sequestration budget cuts, which are affecting defense and non-defense programs alike, with a mix of savings from tax expenditures and mandatory programs.  But revenue-neutral tax reform could foreclose that option by using up all of the politically achievable tax expenditure savings to pay for tax-rate reductions.

An essential ingredient of tax reform — and the one target for policymakers to specify in advance — is therefore a revenue target: one that contributes to a balanced deficit-reduction package that includes replacing sequestration.  Revenues raised through tax reform — including through a “blank slate” approach — should go to lower rates only after this target has been met, as most budget agreements under discussion over the past few years would have done.

This means that while policymakers may have useful exploratory discussions on tax reform now, they should defer actual legislative action until there is a larger fiscal policy agreement that includes a revenue target under which tax reform will contribute meaningfully to deficit reduction.