Robert Shapiro has an interesting article in Slate today on the future of basic tax reform:
The Flat Tax, Flat-Lined - Republicans usually love tax reform. Now that they control Washington, why are they scared of it?.

I do take issue with one paragraph about the benefits of reducing various tax provisions...

Broadening the base means ridding the tax code of the special deductions, credits, exemptions, and allowances that currently shield about half of all income from federal income tax. Trading off a simpler code for lower rates makes macroeconomic sense. Eliminating lots of deductions, credits, and so on would reduce the tax code's influence over how the economy allocates its resources, which is good for growth.

First, this statement assumes that the various "deductions, credits, exemptions, and allowances" are purely the result of special interest influences. If, on the other hand, these provisions were Pigouvian in nature -- that is, set-up to encourage socially beneficial behaviors (like a tax credit for R&D) or discourage socially bad behavior (like polluting) -- then getting rid of them would not be a good idea from an efficiency perspective. Certainly, there is a mix of special interests and Pigouvian tax adjustments in the tax code.

Second, while I might be willing to swallow that ridding the tax code of these provisions might raise the level of production, it is harder to believe that these provisions would have any major impact on growth.

Shapiro also sees one area of inertia in the system:

The first obstacle for any basic tax reform, including a flat tax, is that people value what they have relatively more than what they will receive in the future....Think of support for tax reform as an investment in which you give up deductions or credits today to get lower rates that will spur the economy and raise your income in the future. But people discount the future gains, and rightly so, because the income shielded by tax preferences in the present can earn returns, while there is no certainty that the higher future income will ever arrive.

Personally, I think that the reluctance to give up the deductions is a result of what is called "loss aversion." Loss aversion is the idea that people weight more heavily an actual loss than the equivalent absence of a potential gain (the idea is associated with the Behavioral Economics sub-field - for similar work, see recent Nobel prize winner D. Kahneman).

What now for basic tax code revision? | Posted November 26, 2002 07:00 PM by John Irons