Will tax reform be stable?

Author:Oh, Jason S.
Position::ARTICLE
 
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Stability is essential to any reform's success, yet it is hardly guaranteed. This is particularly true in tax policy, where Congress persistently tinkers. This Article offers a novel approach to studying the stability of reform proposals in taxation. Any reform proposal can be decomposed into its constituent policies. I show that politically extreme policies are more likely to be reversed than are moderate ones. This basic intuition allows one to decompose any tax reform proposal into stable and unstable pieces.

Stability analysis has important implications for tax reform, potentially upending normative prescriptions. First, reform is often justified by appeals to efficiency and fairness. These claims must be appropriately discounted for instability. I demonstrate that some "efficient" or "fair" reforms can be quite inefficient or unfair due to their inherent instability. Second, the overall revenue effect of a proposal depends on its stability. Many so-called "revenue-neutral" proposals may actually reduce revenue once stability is incorporated into the analysis. Such reforms are particularly troubling today given the growing federal deficit.

INTRODUCTION 1160 I. MEASURING THE STABILITY OF INDIVIDUAL POLICIES 1164 A. Where Policies Fall on the Liberal--Conservative Spectrum 1166 B. Extreme Policies Are Less Stable than Moderate Ones 1173 C. Other Factors That Influence Policy Stability 1175 1. Linked Preferences 1176 2. Shifting Preferences and Public-Choice Considerations 1178 3. Strategic Stability 1180 4. Case Study of the Sticky Corporate Tax Rate 1181 II. THE STABILITY OF REFORM 1183 A. Why Are Extreme Policies Enacted? 1186 B. Political Stability Across Congresses 1189 III. DISCOUNTING NORMATIVE JUSTIFICATIONS FOR LIKELY INSTABILITY 1193 A. The Effect of Reform Instability on Fairness and Efficiency 1194 B. Will Revenue-Neutral Reform Remain Revenue-Neutral? 1200 C. The Partial Unraveling of the Tax Reform Act of 1986 1205 D. Should Revenue Estimates Incorporate Political Stability? 1207 IV. APPROACHES TO DESIGNING STABLE REFORM 1209 A. Are Supermajority Requirements the Answer? 1209 B. Reform Outside of the Income Tax Context 1214 CONCLUSION 1219 INTRODUCTION

Will tax reform stick together or fall apart? Stability is essential to any reform's success, yet it is hardly guaranteed. This is particularly true in the tax context. The last century has seen a multitude of well-intentioned tax law changes. Some have lasted while others have not.

When tax reform scholars discuss stability, it is generally from an ex post perspective, after reform has already unraveled. (1) These historical accounts are context-rich but fail to provide specific guidance about the stability of future reforms. This means that tax reform proposals are generally analyzed under the flawed assumption that enacted reforms will remain untouched. (2)

This Article provides an empirical approach to analyzing the ex ante stability of tax reform and demonstrates the importance of stability when evaluating proposals. Tax reform proposals often have major features that are designed to fit together in ways that improve the efficiency, fairness, or simplicity of the tax code. (3) Take one example from the 1986 Tax Reform Act. (4) The capital gains rate was increased to 28%, and the ordinary income rate was decreased to match. (5) There were policy reasons that justified either rate change individually, but notably, several of the strongest arguments were based on the coherence of the two changes taken together. Harmonizing the rates would make the tax system fairer by taxing all income at the same rate. (6) From an efficiency standpoint, it would reduce the money and time spent converting ordinary income into capital gains. (7)

The weight given to these normative justifications should depend on whether these changes are likely to stick. If the harmonization of the capital gains rate and the ordinary income rate is stable, the fairness and efficiency arguments are compelling. On the other hand, if the rates are likely to diverge, those same normative arguments should be discounted by that likelihood.

This Article's intuition is straightforward and powerful. Future Congresses are not required to accept the internal coherence of prior legislation. In fact, Congress often makes changes that undo prior reform efforts. (8) This Article therefore explores stability by decomposing reform and then separately analyzing the political stability of individual policies.

The goals of this Article are both positive and normative. From a positive perspective, the Article shows that some policies are likely to be stable while others are not. It also demonstrates that decomposing reform is a useful way to think about a reform's overall coherence. (9) Normatively, the Article argues for a shift in how tax reform proposals are evaluated. Appeals to efficiency and fairness should be appropriately discounted for stability The stability of a proposed reform is an important variable in how much revenue it ultimately raises (or loses).

Part I describes the Article's approach to studying the stability of individual policies. It focuses on determining how moderate or extreme a policy is relative to legislators' preferences. The U.S. legislative process significantly favors the status quo. (10) Legislative action is only possible if the President and congressional majorities can agree to change policy in the same direction. (11) However, if the President wants to move policy in one direction while the House or Senate wants to move policy in the other, legislative action is impossible. (12) As a consequence, extreme policies are easier to change and tend to be less stable. It is relatively 'more likely that the President and legislative majorities will be able to agree to move an extreme policy in the same direction.

Part II explores the stability of various tax reform proposals. Any proposal can be decomposed into its constituent policies. The tools described in Part I differentiate the stability of those policies based on how politically moderate or extreme they are. (13) Understanding the stable and unstable parts of a reform proposal allows an analysis of the proposal's overall stability.

For example, consider a recent proposal to harmonize the top individual income tax rate, capital gains rate, dividend rate, and corporate rate at 28%. (14) The stability of this reform can be analyzed by considering how moderate or extreme each of these rates is politically. The analysis in Part I suggests that the top marginal rate of 28% and the corporate rate of 28% are slightly conservative policies--right of center but moderate. By contrast, a capital gains and dividend rate of 28% is an extremely liberal policy. This suggests that the top marginal rate and the corporate rate changes will likely be sticky, while the capital gains and dividend rate will not be. (15) The overall proposal is unlikely to be stable.

Part III moves from the positive to the normative. The goal is to incorporate stability explicitly into the evaluation of tax reform. The stability of any proposal informs its ultimate effect on efficiency, fairness, simplicity, and revenue. The normative gains of any reform will often be fleeting if the reform is unstable. Part III works through several examples in which reforms were intended to make the tax system fairer or more efficient but led to unfair and inefficient results when those reforms unraveled in predictable ways.

Parts I through III focus on the stability of reforms of the existing income tax system within the default legislative process. Part IV explores stability outside of this context. First, would a special legislative procedure rule make tax reform more stable? Some scholars have suggested "locking in" a reform by requiring two-thirds congressional supermajorities to enact subsequentchanges. (16) I argue that this procedural change would have only a small effect on making tax reform more stable. Second, do the tools described in this Article provide any insight on the design of non-income taxes? I explore how the tools developed in this Article might inform the design of a federal value-added tax in the future.

  1. MEASURING THE STABILITY OF INDIVIDUAL POLICIES

    Tax reform is complicated--one piece of legislation will simultaneously change rates, deductions, credits, and exclusions, among other provisions. Understanding the stickiness of each individual change is a necessary first step to evaluate whether the overall reform will be stable. (17)

    The more moderate a policy, the more likely it is to be stable. The U.S. legislative process has a strong status quo bias. (18) Legislative action generally requires the approval of the President and congressional majorities. (19) It is more probable that the necessary consensus will form around changing an extreme policy. (20) Thus, extreme policies are less stable because relatively, they are more likely to be changed.

    It is possible to measure how moderate or extreme a policy is based on the ideology of the legislators that identify the policy as their ideal. I employ DW-NOMINATE scores to measure how liberal or conservative various legislators are. DW-NOMINATE is an algorithm that scores each legislator's ideology on a scale from -1 (very liberal) to +1 (very conservative) based on his roll call voting history. (21)

    By looking at the policy preferences of liberal, moderate, and conservative legislators, I can locate where various policies are located on the liberal-conservative spectrum. It surprises no one that such analysis extends to issues of taxation, as ideologically similar legislators share many of the same opinions on tax issues. (22) For example, there are some legislators whose ideal top marginal tax rate is 25%. (23) DW-NOMINATE can measure how conservative such legislators are on average, a fact exploited in this Article.

    In this Article, an "extreme" policy is one that is outside the range of most legislators'...

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