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554 I I I I December 30, 1986 FEDERAL INCOME TAX REFORM RESUMING THE BAlTLE 8 Bruce Bartlett E. L. Wiegand Fellow INTRODUCTION With the ink on the 1986 tax reform law barely dry, fresh discussion of ref orming taxes may seem inappropriate of tax reform should not rest on their laurels job is far from complete. While great progress was made toward improving the equity and efficiency of the tax code during the.first phase of tax reform completed this year, the nation is still far .away from an ideal tax system. The new code is neither as simple nor as fair as was advertised. In fact, the code still contains many unnecessary disincentives, inefficiencies, and biases, which discourage productive activity and e ncourage waste should not rest as long as there are improvements that need to be made. 0 Yet. supporters For, one thing, the Tax reformers For another thing, the fact that a major tax reform bill has been enacted improves the political environment for ach ieving further reforms. attacking Ilsacred cow" deductions, such as mortgage interest relief.

Yet by reducing marginal tax rates substantially, tax reform has eroded much of the deductions' remaining value--and thus erodes the political resistance to furth er streamlining of deductions needed for even lower tax rates will have seen the top tax relief for $1 of mortgage interest fall from 70 cents in 1980 to 28 cents by 19

88. Reduction in rates thus cuts the value of mortgage interest and other deductions b y more than half about abolishing such a deduction than they would have been in 1980 and it is likely that far more would support a reform proposal that A major barrier' to reform always has been a fear of For example, a homeowner in the highest bracket C onsequently, taxpayers now are likely to be far less concernedpromises a true flat-rate tax or other benefits in return for the loss of additional deductions.

There is another compelling reason why tax reformers cannot afford complacency: Those interests w ho stuffed all of the deductions credits, exemptions, and exclusions into the tax code in the first place are still around, and they.wil1 press Congress to restore lost deductions and to add new ones .towthe tax-code The best -way to preserve gains alread y made is to take the offensive by proposing new ref onus As Congress and the Administration get down to business next year, therefore, tax reform needs to be high on the agenda. With the balance of political forces still favoring tax reform, lawmakers can achieve the fair and simple system promised to Americans in 19

86. To do this, Congress must move closer to a genuine flat tax at much lower rates. This can be achieved by eliminating the deductions for all state and local taxes and for mortgage interest and by making Social Security benefits fully taxable If this is done, American will benefit from a greater incentive to work, save, and invest; the tax code will create fewer distortions of people's economic decision making; and there will be a more dynam i c economy, faster economic growth, more jobs, and a rising standard of living for all Americans ENACT A TRUE FLAT-RATE INCOME,TAX Progressivity in the tax code punishes success by taking more than a proportional share.of any gain derived from work, saving , or investment earned, such a tax discourages work, saving, and investment to a greater degree than a flat-rate tax'raising the same revenue.

Economists call this cost the llexcess burden of taxation,Il and research indicates that evgn a mild degree of pr ogressivity imposes a heavy drag on the economy By taxing away. ever 1arger.amounts of each extra dollar 1. For recent estimates of the welfare cost of the U.S. tax system and the gains from tax reform, see Alan J. Auerbach, Laurence J. Kotlikoff, and Jon a than Skinner, "The Efficiency Gains from Dynamic Tax Reform Jnternat ional Economic Review, February 1983, pp 81-100; Charles Stuart Welfare Costs per Dollar of Additional Tax Revenue in the United States American Eco nomic Review, June 1984, pp. 352-362; Charles L. Ballard, John'B.

Shoven, and John Whalley General Equilibrium Computations of the Marginal Welfare Costs of Taxes in the United States bme rican Econom ic Review, March 1985, pp. 128-138; and idem The Total Welfare Cost of the United States Tax System: A General Equilibrium Approach National Tax Jou rnal, June 1985, pp. 125-14.0 2Progressivity also imposes an enormous'compliance cost on the economy. The mere fact of progressivity,.for instance, creates enormous complications and distortions in t he administration of the tax law, which would disappear under a pure flat rate. Law professors Walter J Blum and Harry Kalven, Jr., explained a quarter century ago It is remarkable how much of the day to day work of the lawyer in the income tax fipd deriv e s from the simple fact that the tax is progressive I A flat tax would eliminate many compliance problems. Example there no longer would be any need to differentiate between different forms of income, to be concerned about the timing of income receipts or about splitting income between parent and child or husband and wife. would be gained from such differentiation.

Since the tax rate would be the $ame in every case, nothing Progressivity also prevents equity among taxpayers. Although progressivity exists mainly to impose what is called %ertical" equity (that between taxpayers of different incomes it makes llhorizont a lt equity (that between taxpayers with the same income) virtually impossible to achieve. Example: a taxpayer who receives several years' worth of income in a lump sum, such as a writer receiving an advance 'for a book, pays more taxes than another taxpaye r receiving the same income over the same period of time, who received his income regularly in the form of wages. While this was partly mitigated for a while by income averaging, the 1986 tax bill abolished this provision. Most economists believe that Amer icans.with.the same lifetime incomes ought to pay the same taxes over their lifetimes.

Progressivity makes this virtually impossible A true flat-rate tax would be a bulwark against future tax increases. The reason: to raise taxes it would be necessary to r aise taxes on everyone. One of the greatest evils of progressivity is that it creates the illusion that revenue can be raised by soaking the rich The fact is, however, that not much revenue can be raised from the rich. Confiscating 100 percent of the inco m e of all millionaires would provide only enough revenue to run the federal government for a few days. For example, prior to the 1981 tax cut, the Tax Foundation estimated that, if all the income in the tax brackets from 50 percent to 70 percent were taxed at 100 percent, it would raise only i!enough revenue to run the federal government for six days higher taxes on the l

richI' cannot raise enough revenue to relieve the Thus imposing 2. Walter J. Blum and Harry Kalven, Jr., The Uneasv Case for Progressive Taxation Chicago: University of Chicago Press, 1953 p. 15 3poor. By contrast, tax-rate reductions almost always raise revenue from the wealthy by adjusted gross income, already pay 51 percent of all federal income taxes, according to the Tax Foundation.

I ronically, the ultimate effect of high progressivetax rates has not been lower taxes on the poor, but higher taxes. As Nobel Laureate economist F A. Hayek. points out under--the hillusion- that ;the *burden of taxation has been shifted to the wealthy, les s wealthy citizens are often willing to accept a much heavipr burden than they would otht?rwise have been willing to bear The highest 10 percent of all taxpayers, ranked There also is a constitutional argument against tax-rate progressivity.

Epstein argues that only a flat-rate tax is consistent with the Constitution. This is because government benefits do not increase with incomes.

Fifth Amendment, which says that pepple may not be deprived of their property without just compensation University of Chicago Law School professor Richard Thus progressive tax rates violate the takings clause of the ELIMINATE THE DEDUCTION FOR STATE AND LOCAL TAXES A long litany of arguments exists against the deduction for state and local taxes. The most powerful is that, in e f fect, it subsidizes speiding by state and local governments, by allowing them to.,raise a dollarls worth of revenue at substantially less than a dollar of cost to sheir taxpayers. Naturally, governments raise more revenue, under these circumstances, than t axpayers would be willing to pay without federal deductibility. Indeed, the state and local tax deduction has been called a form of state-initiated revenue sharing 3. For evidence on the Reagan tax cut, see Lawrence B. Lindsey, Taxoave r Behavior and the D istribution of the 1982 Tax Cut Working Paper No. 1760 (Cambridge, Massachusetts National Bureau of Economic Research, October 1985); idem, Establ ishing the Revenue Maximizing TOD Personal Tax Rate, Working Paper No. 1761 (Cambridge, Massachusetts Nation a l Bureau of Economic Research, October 1985). For evidence on earlier tax cuts, see James Gwartney and Richard Stroup, Tax Cuts: Who Shoulders the Burden? Federal Reserve Bank of Atlanta Econom ic Review, March 1982, pp. 19-27 4. F. A. Hayek, The Constitu t ion of Libertv (Chicago: University of Chicago Press 1960), p. 311 5. Richard Epstein, Takings: Private Prooertv and the Power of Eminent Domain Cambridge, Massachusetts: Harvard University Press; 1985). pp. 295-302 4According to Congressional Research Se rvice calculations, thanks to deductibility, state and local governmentnspending Qs over 20 percent higher than it would be without deductibility.

Council on Intergovernmental Relations estimates that spending is 7 percent higher as a result of deductibili ty, while research by economists Roger Gordon and Joel Slemrod indicates that state and local governmept spending-would fa11-.13 0.6 percent without deductibility. The elimination of deductibility, writes Professor Helen Ladd of Harvard, would reduce the g emand for state and local government services by about 14 percent. And University of Michigan economics professor Edward Gramlich estimates that state and local government spendipg in Michidan would fall 10 percent in the'absence of deductibility to state and local governments in the form of deductibility for state and local taxes. The corresponding loss of federal revenue is estimated by the Treasury at over $30 billion in fiscal year 1986 Not only does deductibility encourage states and localities to rai s e more revenue than their citizens otherwise would tolerate, it encourages them to raise such revenue in the form of progressive income taxes. This is because the advantages of deductibility The Advisory In short, the federal government is providing an en o rmous subsidy increase with a state and local higher marginal tax bracket. The result: progressive taxes meet less voter resistance when superimposed on 6. Nonna A. Noto and Dennis Zimmerman, Limitinn State-Local Ta x Deductibilitv in Exchange for Increas e d General Revenue S h a rin g An Ana lvsis of the Econom ic Effects Committee Print, Senate Committee on Governmental Affairs, 98th Congress, 1st Session (Washington D.C.: U.S. Government Printing Office, 1983 p 11. See also Dennis Zimmerman Resource Misa l location From Interstate Tax Exportation: Estimates of Excess Spending and Welfare Loss in a Median Voter Framework Nat ional Tax Jou rnaG June 1983, pp. 183-201 7. Strengthening the Federal Re venue Svste m: ImDlications for Sm a nd Local Ta Xing and Bor r owinq (Washington, D.C.: Advisory Commission on Intergovernmental Relations, 1984 p. 48; Roger H. Gordon and Joel Slemrod A General Equilibrium Simulation Study of Subsidies to Municipal Expenditures Journal of F inance May 1983, pp. 585-594 8. Helen F. L a dd, "Federal Aid to State and Local Governments in Gregory B. Mills and John L. Palmer, eds., Fede ral Budget Policv in the 1980 Washington, D.C.: The Urban Institute, 1984 p. 195 9. Edward M. Gramlich The Deductibility of State and Local Taxes National T a X Journal, December 1985, pp. 447-465 5a progressive federal tax wealthy are offset in great part by increased federa1,tax savings.

The benefits of deductibility vary widely among states states with the highest taxes and the highest tax rates enjoy the g reatest benefits from federal deductibility As a result, Americans in states with low taxes are penalized by paying part of their federal taxes to offset. lost fefierak-revenues caused by .deductibility. in states with high taxes. In essence, deductibilit y redistributes The higher state tax rates paid by thelo Those income from low-tax to high-tax states By forcing all federal taxpayers to carry part of the burden of state and local taxes, dedytibility inhibit,s tax reduction efforts at the state and local level. It also inhibits privatization efforts at the state' and local level. This is because deductibility 'often means that governments can provide services at a lower after-tax cost than can the private secbor, even though the private services are actua lly less expensive. Similarly, deductibility discourages governments from charging usfir fees for services since fees are not deductible, while taxes are.

The main argument'usual1y.voiced against eliminating deductibility is that states would simply shift their tax burden ontp corporatips, which would be able to deduct such taxes as business expenses. If this were to happen, however, it would lead to an exodus of businesses from high-tax states. Research indicates that businesses, especially small finds th at provide. the bulk. of new jobs 10. Edward Moscovitch State Graduated Income Taxes--A State-Initiated Form of Federal Revenue Sharing National Tax Journal, March 1972, pp. 53-

64. See also Robert I.

Keller, "The Case .for Highly Graduated Rates in State Income Taxes Marvland Law Review, 1976, pp. 617-650 I 11. This point was emphasized by the Treasury Department. See Tax Ref0 rm for Fairness Simolicitv. and Economic G rowth: The Treasurv Deoartment Reoort to the P resident Washington, D.C U.S. Governmen t Printing Office, November 1984), p. 64 12. "Deductibility Hurts Local Tax' Cut Efforts Dollars Sensg July-August 1985i.P: 7 13. E. S. Savas Tax Plan's Boost to Erivatizing Services," The Wal 1 Street Jo urnal July 10, 1985, p. 28 14. Harry P. Hatry pI 1s r D iv f P 1' ervice Washington, D.C.: The Urban Institute, 1983), p. 90 15. Martin Feldstein A Tax-Reform Mirage The Wall Street Jou rnal, November 20, 1985.

See also Martin Feldstein and Gilbert Metcalf, The Effect of Federal Tax Deductibilitv on State and Local Taxes and Soe ndinq, Working Paper No. 1791 (Cambridge, Massachusetts National Bureau of Economic Research, January 1986 6are highly sensitive to state and local tages. They will move or expand elsewhere if taxes are excessive. The fear of such a n exodus would constrain states from shifting the tax burden from individuals to businesses. liberals already would have raised state business taxes above their current levels to finance additional welfare and other government spending. The reason they ha v e not done,so is precisely because they fear that in states- like' New York businesses"will"'fleeh*to I lower-taxed jurisdictions or expand their operations outside New York If it were easy to tax business, moreover The other main argument against elimina t ing deductibility is that it would constitute a %ax on a tax," the idea being that the amount of taxes paid to state and local governments should not, in effect, be considered federal taxable income. Were this the case, however, Congress would have to mak e all taxes deductible, including federal taxes. But it explicitly rejected this rationale some time ago ypen it ended the deductibility of federal excise and gasoline taxes.

This rationale similarly would require states to allpw deductibility of federal t axes fBom state taxable income such a deduction. Ironically, New York Governor Mario Cuomo, who led the fight against the elimination of deductibility and heavily used the "tax on a tax argument, refused to allow New York City residents to deduct their ci t y taxes on their state tax returns Yet only 16 states allow c Eliminating the deductibility of state and local property and income taxes would haye desirable effects =ten if it did not lead to further reductions in tax rates. In fact, Lt would raise subst a ntial revenues that could be applied to further rite reductions TAX SOCIAL SECURITY BENEFITS Until 1983 Social Security benefits were completely exempted from federal income tax. This tax-free status was based on a 1941 Internal Revenue Service ruling how e ver,.always have been fully taxable to the extent that benefits exceed contributions. Today's elderly are one of America's more wealthy groups. A recent Conference Board study finds that, awhile Americans over age 50 account for just 35 percent of the adu l t Private and other government pensions I 16. See, for example, Ronald E. Grieson gt aL. "The Effect of Business Taxation on the Location of Industry J 1 April 1977, pp 170-185 17. Richard Goode, The Ind ividual'hcome Tax, revised ed Washington, D.C.: The Brookings Institution, 1976), pp. 169-170 18. Sianificant Featu res of Fiscal Federalism. 1985-86 Edition (Washington, D.C Advisory Commission on Intergovernmental Relations, February 1986 p. 78 G 7population, they receive 42 percent of the nation's after -tax incomer An astounding 77 percent of the nation's household financial wealth-stocks, bonds, and cash-is in the hands of this generation.

In shBrt, the image of the elderly as a poor group is just not true.

Those retired Americans who are poor, moreover, would not pay federal income kaxes anyway And-since .effective tax rates' rise with income, those most in need would be unaffected by the proposal, and the facto reduction in benefits would affect only those with upper incomes. For this reason, taxing Social Security oenefits often has been proposed even by liberals. In 1982, for example, Democratic Governor Bruce Babbitt of Arizona strongly endorsed taxation of Social Security benefits Subjecting Social Secu r ity benefits to income taxation," he said would spread any given amount of cuts more equitably: Lower-income recipients would pay little or no tax while upper-income recipients would be subject to the progressive structure of the income tax.1f2o Editorial i zed The Washinuton Post in 1980 Of all the ways to trim Social Security, some version of taxation is the most sensible system for the bulk of their income and] the fiscal stability of the system would be improved substantially. lr2 Others who have support ed taxing benefits include former Commissioner of Social Security Robert M. Ball and econo:aists Alicia Munnell of the Federal Reserve Bank of Boston, Sylvester J. Schieber of the Employee Benefit Research Institute, Mickey D. Lev of the.

American Enterpri se Institute, Henry Aaron of the Brookiigs It is.least damaging to those who rely on the 19 The New Old Where the Economic Action Is Business Week, November 25, 1985 pp. 138-140; Spencer Rich Many Elderly Can Afford Luxuries, Study Says The Washinnton Pos t, December 17, 1985, p. A3; Thomas E. Ricks People3 Perception of the Elderly as Being Poor Is Starting to Fade The Wall Street Jo urnal, December 19, 1985.

See also Samuel H. Preston Children and the Elderly in the U.S ientific Am erican December 1984 pp . 44-49; Alvin Rabushka and.Bruce Jacobs, Old Folks at Home (New York The Free Press, 1980); Henry J. Aaron, Economic Effects o f Social Secu ritv (Washington D.C.: The Brookings Institution, 1982), pp. 68-72; Michael Hurd and John B. Shoven Real Income a n d Wealth of the Elderly," American Economic Review, May 1982, pp. 314-318; and Econom ic Reo0 rt of the President (Washington, D.C.: U.S. Government Printing Office 1985 PP. 159-186 20. Bruce Babbitt For Taxes On Benefits The New York Times, December 22, 1 982 21 And on Social Security The Washinnton Post, May 19, 1980, p. A16 8 I Institution, and Rudolph Penfier, outgoing director of the Congressional Budget Office. In short, it is an idea with considerable intellectual and political support Two principal a rguments against taxing benefits are made. The first is that the taxation of current retirees' benefits would break faith with those who made their retirement plans assuming that their Social Security- benefits .would.-not be-taxed This view- regards the S ocial Security system as a private pension, in which there is a contractual right to benefits. In fact, as University of Missouri law professor Christopher Hoyt explains: "Despite the appearance of a contractual or proprietary right, one is not automatica l ly entitled to Social Security benefits by virtue of paying Social Security Congress has frequently denied benefits to those who have paid substantial Social Security taxes and altered benefits formulas up and down. For example, the so-called earnings tes t reduces an individual's Social Security benefits if he or she has earned income over a certain level and is under the age of

70. In any event, the Social Security legislation of 1983 began taxing part of the benefits taxes Or, one might add, to any spec ific level of benefits 22. Robert M. Ball, SOC' ml Securitv: Todav a n d To m o r ro w (New York: Columbia .University Press, 1978), pp 478-479; Alicia H. Munnell, The Future of SOC ial Securitv Washington, D.C.: The Brookings Institution, 1977), pp. 29-3 0 ; ideq Is, It Time to Start Taxing Social Security Benefits New Ennland Economic Re v' le w, May/June 1982, pp 18-27; Sylvester J. Schieber Thinking the Unthinkable: A Tax on Social Security The yashinnton Post December 26, 1982; Mickey D. Levy, The Tax T r eatment of Social Securitv: Should the Exclusa 'on of Benefits Be Eliminated Washington, D.C.: American Enterprise Institute, 1980); and U.S. Congress, Senate, Committee on Finance, Socia ss, frh r 97th Congress, 1st Session (Washington D.C.: U.S. Governm e nt Printing Office, 1981). part 1, pp. 74, 82 23. Christopher Hoyt, "Income Taxation of Social Security Benefits: Balancing Social Policy with Tax Policy UMKC .Law Review, Spring 1986, p 415 24. The earnings test imposes severe marginal tax rates on the w o rking elderly, strongly contributing to the low labor force participation rates by the elderly. Indeed, the disincentive effects are so strong that even the Social Security Administration admits that elimination of the earnings test might raise revenues m ore than benefits are increased. See Josephine G. Gordon and Robert N. Schoeplein, "Tax Impact From Elimination of the Retirement Test Bc i a1 Securitv Bull e tin , September 1979; pp. 22-

32. For further discussion, see Marshall Colberg, The Social ir m n Te t- Ri h or Wronc (Washington, D.C.: American Enterprise Institute, 1978); Anthony J. Pellechio The Social Securitv Earnings Tes t. Labor SUDD~V Distortions. a nd Fo regone Pavroll Tax Revenue, Working Paper No. 272 (Cambridge, Massachusetts: National B ureau of Economic Research, August 1978); and U.S. Congress, Senate, Committee on Finance, Social Securitv Retirement Test, 96th Congress, 2nd Session (Washington, D.C.: U.S. Government Printing Off ice, 1980 i -9of those retirees with taxable income abov e $20,000 for single persons, and above $25,000 for couples.

The second argument raised against taxing Social Security benefits is that it would take money away from those living on limited fixed incomes. But those'with low incomes, in effect, would be exe mpt from the provision, for they would pay almost no taxes anyway applies to even more retirees"sinc'e the '1986" tax l'w raised" the personal exemption and lowered tax rates This ELIMINATE THE DEDUCTION FOR MORTGAGE INTEREST I I .I Many provisions that f a vor home ownership remain in the federal tax code. Property taxes are fully deductible, for example, while capital gains on home sales are not taxed at all if they are reinvested in another primary residence. Taxpayers over age 55 moreover, can pocket tax free up to $125,000 of capital gains on home sales interest, which costs the Treasury an estimated $27 billion in fiscal year 1986 There are good reasons for eliminating the deduction for mortgage interest apart from the need to raise revenue to permit ta x -rate reductions. It encourages, for example, what probably is excessive homeownership at the expense of using capital for businessiinvestment thereby reducingJJ.S. productivity and international competitiveness. This misallocation is enormous. According t o the Commerce Department, the gross stock of U.S., owne&-occupied, nonfarm residential capital in 1985 totaled $3.6 trillion. Various estimates put the excess investment in home ownership, caused bgthe tax treatment of housing, at between 4 and 5 percent age points.

This suggests that as much as $180 billion of capital has been The fattest homeowner benefit is the deductibility of mortgage 25. See Congressional Budget Office, The Tax Treatment of Homeo W nersb Issues a nd Ootiong (Washington, D.C U.S. Gove rnment Printing Office, 1981), pp. 6-17 26. Patric H. Hendershott Government Policy and the Allocation of Capital Between Residential and Industrial Uses," Financial Analysts Journa I, July-August 1983, pp 37-

42. I 27. "Fixed Reproducible Tangible Wealth in the United States, 1982-85 Survev of Cu rrent Business August 1986, p. 38 28. Congressional Budget Office, Tax Treatment of Homeo wnershiD, p 27. See also Harvey S. Rosen Housing Subsidies: Effects on Housing Decisions, Efficiency, and Equity in Alan J. Auerbach and Martin Feldstein, eds., Handbook of Public Eco nomics, 2 vols New York: North-Holland, 1985), vol. I, pp. 395-400 10 -misallocaked--equivalent to almost half of all nonresidential fixed investment in the U.S. in 19

85. U.S.'productivity surely would be much higher if this capital had been invested in new factories and equipment instead of housing.

Another argument for eliminating the mortgage interest deduction is that by favoring housing it allows special interest groups to argue that fair ness--and consistencymrequire that.they-too-be allowed'tax breaks. Charles McClure, former Deputy Assistant Secretary of the Treasury for Tax Analysis, explains: "Defenders of tax breaks for both rental housing and business investment can argue with some j ustification that tax reform is unacceptable, even by the standards of its advocates, who speak in tenus of a level playing field, as long as owner-occupied housing continues to enjoy a uniquely favorable status dQ Mortgage interest deductibility also is unfair because the benefits accrue only to homeowners and not to renters and because the tax savings rise with the taxpayer's marginal tax rate, and therefore, with income.

The 1986 tax law, with its dramatic reduction in marginal tax rates, already has er oded the benefit of the mortgage deduction is the principal reason why the complete elimination of the deduction no longer is as politically unrealistic as it once was possibility that the loss of the deduction would lead to a further drop in marginal tax rates could convince many homeowners that the t:rade-off is worth making. In 1981, the Congressional Budget Office estimated that, under the tax code at that time, eliminating all s:3ecial tax breaks for homeownership would allow for a 10 percent reductio 8 in all marginal tax rates across the board with no loss of revenue 65 percent of all households are owner-occupiers majority of taxpayers would not suffer from loss of the mortgage interest deduction. Instead, they would benefit from lower tax rates This The And because only 37 percent of households itemize, while the vast While there will be stiff resistance to eliminating the mortgage deduction from some groups, the potential of this resistance has been weakened because of the marginal-tax-rate reductio n s since Ronald Reagan became President 29. Charles E. McClure, Jt The Tax Treatment of Owner-Occupied Housing: The Achilles Heel of Tax Reform?" in James R. Follain, ed., nx Ref0 rm and Real Estate (Washington D.C.: The Urban Institute, 1986). p 226 30. C o ngressional Budget Office, Tax Treatment of Homeowntrshig p 40 31. Joel B. Slemrod, "The Effect of Tax Simplification. on Individuals," in Economis Conseaue nces of Tax Simdification (Boston: Federal Reserve Bank of Boston, 1985 p. 82 11 CONCLUSION The ba t tle over tax reform is about to resume. Those who benefit from special tax breaks can be expected to try to turn next year's legislation, designed to make technical corrections in the 1986 tax bill, into a major bill, that restores --some of- the benefits .lost in 1986 tax reform legislation. Since tax legislation will continue to be considered and enacted, it is vital that supporters of genuine reform press their case by offering new initiatives consistent with the principles embodied in Reagan's original tax reform proposal.

They should continue efforts to broaden the tax base and reduce marginal tax rates, aiming at a low flat rate. They should strive to treat taxpayers with similar incomes in the same way, to remove disincentives to work, saving, and in vestment, and to achieve greater fairness and equity in taxation.

Historically, a major barrier to the enactment of meaningful reforms has been a fear of attacking the "sacred cows" in the tax code. The fear has been that the perceived losses suffered by those benefiting from specific provisions of the tax code would cause them to block reform proposals. The experience of 1986, however, suggests that American taxpayers are willing to gi v e up loopholes in return.for lower rates include: taxes according to the Office of Management and Budget To "payv' for lower rates, a .number of steps can be taken. They 1) Eliminate the deduction for state and local nonbusiness This would have raised 33. 3 billion in fiscal year 1986 2) Tax Social Security.benefits. This would have raised $13.5 billion in 1986 3) Eliminate the deduction fog mortgage interest. This would have raised 26.9 billion in 1986.

Enough revenue could be left over to raise the personal 'exemption further and make other desirable reforms, such as expanding Individual Retirement Accounts.

Some will say that with the reforms already enacted there is no longer political support for further reforms In fact, the opposite is true. The chang es enacted make it possible for the first time to legislate reforms that would indeed have been politically impossible 32. These figures will, of course, be substantially altered by the 1986 tax law 12 to contemplate a few years ago. The reduction in rate s enacted in 1981 and 1986 have eroded significantly the value of all remaining deductions and exclusions.

There still are considerable economic and political benefits to be derived from tax reform. Those supporting such reforms should prepare so that, whe n the inevitable tax bill comes along, they are ready to make. theiz case lest the I eif art- once again-be dominated by the special interests I 13