Taxes 2013: Why Tax Reform Won't Be Enough to Solve Our Fiscal Crisis

The U.S. tax code is a mess. According to the National Taxpayer Advocate's 2012 Annual Report to Congress, Americans spend 6.1 billion hours each year complying with a tax code almost 4 million words long. More than half of Americans are forced to pay someone else to do their taxes, but even these professional have trouble understanding the law, as studies repeatedly show an alarming error rate among preparers.

Even worse, the current tax code is economically destructive. Special interest carve outs and loopholes distort behavior by favoring certain activities over others. The double taxation of savings and investment similarly encourages people to spend and accumulate debt, reducing the available pool of capital to expand businesses and grow the economy.

There is every reason to reform the U.S. tax code, but little reason to suspect that politicians are prepared to do so in a sensible way. And even if they did, it wouldn't solve the debt crisis.

The goal of tax policy should simply be to raise enough revenue to fund the necessary function of government while do as little damage to the economy as possible, and the tax code shouldn't be used to entice certain behavior that politicians find desirable. Thus the objective should be to establish a system with low marginal tax rates to minimize penalties on work, entrepreneurship and other productive behavior – such as with a flat tax or national sales tax – no double taxation of savings and investment, and no distortionary loopholes. But I fear that any package able to navigate the current political and partisan landscape is unlikely to contain these features.

It's true that many lawmakers are talking tax reform. House Ways and Means Chairman Dave Camp (R-Mich.) has long sought tax reform, and is feeling pressure to act soon due to the fact that Republican House rules will force the chairman of the powerful committee out of his post after the 113th Congress – though Representative Paul Ryan (R-Wisc.) received a waiver to the term limit rules after the last Congress. With the threat of losing the prime tax writing Chairmanship looming, Camp is determined to pursue comprehensive reform, and has recently announced the formation of 11 separate Working Groups to tackle different aspects of the code. Though it's unclear whether House leadership is willing to bring any reform package to a vote.

Republicans are weary of negotiating with President Obama, who along with his Senate colleagues has made clear that Democrats view "tax reform" to be synonymous with "tax increase." Already smarting over their inability to secure real spending cuts in exchange for tax hikes, Republicans see little to be gained by opening up the entire tax code for revision while a tax and spend president occupies the oval office.

But even if the perfect tax reform package emerged it wouldn't solve the nation's debt crisis, which is actually just a symptom of Washington's spending problem. As high tax European nations have demonstrated with their own debt crises, there is no amount of revenue capable of satisfying an unrestrained political desire to spend other people's money in pursuit of votes.

The spending problem is itself in large part an entitlement problem.

Entitlements have grown from less than half of total federal outlays just 20 years ago to almost 62% in 2012, and it's only going to get worse. The three major mandatory spending programs – Social Security, Medicare, Medicaid – along with the president's new health care entitlement, are primarily responsible for projected spending growth, and by mid-century those three programs alone will eat up over 18% of the nation's economic output. Mandatory spending is also crowding out other priorities, and by 2040 is projected along with interest payments to consume 82% of the total budget.

The debt crisis is an entitlement and spending crisis, and can only be solved by addressing those issues. Tax reform is sorely needing, but it is not sufficient for achieving fiscal sustainability. That will require real spending restraint and significant entitlement reform.