Tax Reform and Channeling Reagan

The day after the midterms, a conservative columnist and a Democratic senator struck the same fiscal chord. Looking ahead, they looked back with longing at America’s last meaningful tax reform.

Here’s Evan Bayh of Indiana, telling fellow Democrats how to shake it off and get their mojo back: “A good place to start would be tax reform….Reward savings and investment. Simplify the code to reduce compliance costs and broaden the base. In 1986, this approach attracted bipartisan support and fostered growth.”

And here’s Ross Douthat, blogging “[N]early all the historical models for the kind of big reforms I’d like to see—the Reagan tax overhauls, the budget deals of the Clinton and first Bush presidencies…took place amid divided government…”

Ronald Reagan’s Tax Reform Act of 1986 is the bill Bayh praised and the most sweeping of those hailed by Douthat. Neither Bayh nor Douthat mentioned, but both surely know, that one of the bill’s signature provisions could bring a strong tax-equity case to the debates shaping up on the Hill—first over extending the Bush cuts, then over tax policy in general.

In 1986, taking a step long sought by liberals, Reagan equalized taxes on income from investments and income from wages. With his last fiscal legacy, he ended more than six decades of lower taxes on income from wealth than income from work.

What persuaded him? In a section titled “Fairness,” the bipartisan Joint Committee on Taxation laid out the case. The opening minces no words: A primary objective of Congress was to provide a tax system that ensures that individuals with similar incomes pay similar amounts of tax. The ability of some individuals to reduce their tax liability excessively under prior law eroded the tax base and required tax rates to be higher than otherwise would have been necessary.

Tax breaks on capital gains came roaring back in 1997 under President Clinton and were sweetened again in 2003 by President Bush. The current rate on long-term gains stands at 15 percent, the lowest since FDR’s first term. According to the K Street spin, capital gains deserve lower rates; after all, the spinners claim, buying shares in the market grows businesses, grows jobs, and grows the economy.

In their dreams.

In reality, only a trace amount of the billions that change hands on Wall Street every day grows anything. Aside from initial public offerings and secondary offerings, not a dime that’s invested in the market goes to companies. In fact, through dividends and stock buybacks, money flows in the opposite direction—out of companies, into the hands of investors. These investors aren’t growing companies, they’re growing portfolios.

Making money in the market is a wonderful thing. It’s un-wonderful to tax market gains at a lower rate than wages, benefiting only the haves, the have-mores, and especially the have-mosts. (Except, that is, for those IPOs and secondary offerings. Gains from those transactions have a strong claim to accrue tax-free.)

Finally, in a change as basic as any made by Reagan, President Obama and Congress should shift the tax-break focus from stocks to corporate bonds. Although some bond issues simply retire debt, most raise money to upgrade and expand facilities, open new plants, and hire new people. It’s bonds—not aftermarket stock buys—that really do grow jobs and grow the economy.

Give bond interest a tax break. “Reward investment,” Senator Bayh urged. Back to you, senator (likewise, every other member of Congress).

A final report from the bipartisan National Commission on Fiscal Responsibility and Reform, with its master plan for deficit reduction, is due at the White House on December 1. Then it’s up to Obama and Congress. From both ends of Pennsylvania Avenue, Americans deserve the same fairness and boldness that marked Ronald Reagan’s Tax Reform Act of 1986.

Gerald E. Scorse helped pass the bill requiring basis reporting for capital gains. It will begin to take effect in 2011.