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Tax reform, Reagan style, may be a tougher fit for Trump

  • Congress now confronts an issue that business-minded Republicans (and many Democrats) really care about: tax reform.
  • The stakes couldn't be higher for Republicans in Congress and the Trump administration.
  • A good place to start, say many Republicans and Democrats, is the Tax Reform Act of 1986, enacted under President Ronald Reagan with bipartisan support.
Donald Trump
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Donald Trump

With efforts to reshape health care seemingly in shambles, Congress now confronts an issue that business-minded Republicans (and many Democrats) really care about: tax reform.

As Senator Ron Johnson, Republican of Wisconsin, put it this week, "We've got to move on to tax reform so we have a competitive tax system," and do it "pretty quickly." The House Ways and Means Committee continued hearings on tax legislation on Wednesday.

The stakes couldn't be higher for Republicans in Congress and the Trump administration, all anxious to demonstrate that a party that controls the White House and both houses of Congress can accomplish something significant and deliver on at least one major campaign promise.

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So what would be the elements of a tax reform plan that is fair and simple and will stimulate growth — not to mention attract at least 50 Republican votes in the Senate?

A good place to start, say many Republicans and Democrats, is the Tax Reform Act of 1986, enacted under President Ronald Reagan with bipartisan support.

Almost everyone, it now seems, loves it.

Those behind the House Republicans' tax plan — including the speaker, Paul D. Ryan of Wisconsin, and the Ways and Means chairman, Kevin Brady of Texas — went to great lengths to praise Reagan's accomplishment in their tax reform manifesto, "A Better Way."

"President Reagan was willing to lead on tax reform," they wrote. "As a result of that leadership and three years of difficult work in Congress, the United States emerged with one of the most modern, fair and competitive tax systems in the developed world — one that laid the foundation for decades of American job growth."

Byron Dorgan, a former Democratic senator and representative from North Dakota, and a member of the House Ways and Means Committee that approved the 1986 bill, wrote in The Hill this year: "It was widely celebrated as a major success. We eliminated many deductions and special deals in the tax code, used the savings to substantially lower the top tax rate to 28 percent, and also simplified the tax code."

The 1986 reform also achieved the elusive goal of being "revenue neutral" (meaning it neither expanded the deficit nor entailed an overall tax increase) even as it cut the top individual rate from 50 percent to 28 percent. The top corporate rate declined to 34 percent, at the time the lowest corporate rate in the developed world, from 46 percent. The legislation offset the loss of revenue by broadening the base — eliminating a host of deductions, exemptions and credits, including many abusive tax shelters. It also greatly simplified returns for millions of taxpayers.

Legislators sold the bill to voters as a fair, efficient, simple spur to economic growth, and it proved enormously popular, one of Reagan's enduring accomplishments. The economy (and the stock market) soared. But over the years, much of it was undone as lobbyists and special interests pushed new preferences into the tax code.

As Mr. Brady said this week: "America now has one of the most costly, unfair, and uncompetitive tax systems in the world. The need for pro-growth tax reform is urgent."

So why not go back to 1986 and simply restore the principle that worked so well then — lower tax rates, along with a broader base that avoids increasing the deficit?

It turns out that many people have tried. The most recent example came in 2014, with tax reform legislation drafted by the Ways and Means Committee, led at the time by Representative Dave Camp of Michigan, a Republican who retired from politics in 2015. The legislation followed 30 congressional hearings dedicated to tax reform and 11 separate bipartisan tax reform working groups led by Mr. Camp and Representative Sander Levin of Michigan, then the ranking Democrat on the committee.

The Camp reform proposal cut rates and closed loopholes. The bipartisan Joint Committee on Taxation estimated it would lead to the creation of 1.8 million jobs and add up to $3.4 trillion to the gross domestic product without adding to the deficit. The committee estimated that the bill would save an average middle-class family of four $1,300 per year in federal taxes.

"I took as inspiration the 1986 act," Mr. Camp told me this week. "We adopted the same structure and approach. We reduced rates and broadened the base. I felt good about that."

Mr. Camp's effort drew bipartisan praise. "I applaud it," said C. Eugene Steuerle, a co-founder and fellow of the Urban-Brookings Tax Policy Center, a key architect of the 1986 reform act and former deputy assistant secretary of the Treasury for tax policy. While it needed a few amendments, he said, over all "it was rigorous, based on clear principles, and didn't rely on magic money" to avoid expanding the deficit.

The Camp bill never even made it to the House floor.

"You can't just go back to 1986 today," said Michael J. Graetz, a professor and tax specialist at Columbia and Yale law schools who has written extensively about the 1986 act. Then, there were numerous tax shelters, loopholes and other sources of revenue. Today, "there's no pot of gold to pay for the cuts, the way there was back in 1986," Mr. Graetz said.

Even though it nominally cut corporate rates, the 1986 act actually shifted much of the tax burden from individuals to corporations. That's not feasible today, where lowering the tax burden on corporations is a major goal.

That was a reality that Mr. Camp had to confront. "The Camp plan turned out to be a reality test," Mr. Graetz said. "There was a lot of pain in the Camp bill in terms of eliminating tax deductions and credits. And that only got you to a 25 percent corporate rate. President Obama used to say he could get us to 28 percent, also with a lot of pain. But it's hard to get the business community excited about 28 percent or 25 percent, especially now that the U.K. is moving to 17 percent and Canada is close to that."

And Mr. Camp's plan wasn't able to lower individual rates much at all — devising three brackets, taxed at 10 percent, 25 percent and 35 percent. But it phased out certain deductions and exemptions for people making over $400,000 a year. The Tax Foundation calculated that some taxpayers making more than $400,000 would pay a marginal rate as high as 43.8 percent, in effect a tax increase on the wealthy. It also hit rich taxpayers by lowering the cap on mortgage deductions to $500,000, from $1 million.

And the Camp plan actually raised the top effective rate on capital gains and dividends to 24.8 percent, from 23.8 percent, according to the Tax Foundation.

That was anathema to many Republicans.

Some of the "pain" inflicted by the Camp plan also hits especially close to the Trump White House, since it proposed closing some of the biggest loopholes for real estate developers. Mr. Camp's plan eliminated the break for so-called like-kind exchanges, which many real estate developers use to delay or avoid capital gains tax.

And the Camp plan proposed longer depreciation schedules, reducing the deductions that businesses can take for capital investment and thus increasing taxes for most real estate developers. The Trump plan calls for immediate expensing of 100 percent of capital costs, eliminating depreciation altogether — an enormous windfall for real estate interests.

It should probably come as no surprise that one person who didn't like the Tax Reform Act of 1986 was Mr. Trump. "One of the worst ideas in recent history," was how he described it in a 1986 op-ed piece in The Wall Street Journal.

Suffice it to say that anything resembling the 1986 act would appear to be dead on arrival with this administration and Congress, even though many tax experts support such an approach.

"Camp's approach is what responsible tax reform should look like, and he garnered no support from either Republicans or Democrats," Mr. Graetz said.

That doesn't mean people are giving up hope. "I'm still optimistic we can conclude tax reform this year," said Mr. Camp, now a senior policy adviser at the tax, accounting and consulting firm PwC. He's been encouraged that Trump administration officials have recently reached out to him.

"The issues are difficult but it's not nearly as partisan as health care," he said. "There's been a lot of work done on tax policy over the years, and I think we can build on that. Most people agree there's an urgent need for tax reform, and I see this as a tremendous opportunity."