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Taxes: How to Fix Our Broken System

Tax expert
Rosanne Altshuler

Unless you are an accountant, your annual run-in with the U.S.
tax code is probably one of the most infuriating and bewildering lowlights of
your year. And even once you've managed to href="">wrestle your 1040 into submission, the news
is still bad: Our tax system brings in far less money than we need to run the
government. (The deficit for 2009 alone was more than $1.4 trillion.) Can
anything be done to change it? And if so, what?

Rosanne Altshuler, co-director of the href="">Urban-Brookings
Tax Policy Center, is well-equipped to answer such questions.
Altshuler was Senior Economist to President Bush’s bipartisan
Advisory Panel on Federal Tax Reform in 2005, Special Advisor to the Joint
Committee on Taxation, and consultant to the U.S. Treasury Department and Canadian
Department of Finance. From 2001 to 2006, she edited the href="">National Tax Journal.

In this exclusive interview with MoneyWatch, Altshuler
shares her views on the U.S. tax system, and whether it can be fixed.

Why can’t we just muddle through with the tax system we have now?

Policy makers are going to have to confront this fact
soon: They will not be able to raise the revenues required to solve href="">our budget problems solely by taxing the
rich. Once they recognize this, there is the possibility of href="">broad-based tax reform. I would guess this
could occur in 2011 or early 2012.

What’s bad about the current system?

In general, it’s inefficient and unfair. People
make decisions that are driven by tax concerns, decisions they would not make
in the absence of taxes. We want a system that distorts behavior as little as
possible while still raising the revenue required to run the government.

When you have a tax system that is hard to understand and
full of loopholes, and people see their neighbors taking advantage of
provisions they are not aware of, people start losing faith in the system. I
find that troubling. You can get very uneven outcomes even among people in
similar situations and level of income.

Is there anything good about it?

Well, it’s good that Americans pay their taxes.
They voluntarily comply at a high rate compared to other countries. And it’s
good that the system is progressive, meaning that tax rates increase with
income. That’s about it.

What are the chances we are going to see tax reform this year?

The landscape right now is very interesting. The Bush tax
cuts from 2001 and 2003 are set to expire at the end of 2010, and as of January
1, 2011 the tax code turns into a pumpkin — tax law reverts back to
what it was prior to 2001. The Obama administration wants to allow the 2001 and
2003 tax cuts to expire, but only for families making more than $250,000 and
individuals who make $200,000 or more.

Many people believed that the impending expiration of the
Bush tax cuts would create the impetus for real tax reform. But there doesn’t
seem to be a push for that within the administration. I can’t imagine
a serious reform happening before the mid-term elections in November.

What are the barriers to reform in 2010?

One problem is the economy. No one wants to raise taxes for fear that it would destroy our nascent economic recovery. Another problem
is that the President has made a pledge not to increase taxes on families
making less than $250,000 a year, and a number of Republicans in Congress have
pledged not to approve any new taxes. Together, that adds up to a climate of no
new tax hikes. But of course we need revenue, so something has to give.

The president’s panel on tax reform, led by Paul Volcker, is
supposed to report shortly. What do you expect from it?

They have said that they will deliver an “almanac”
of ideas for reform. I find that disappointing. There are a lot of ideas out
there already. The Volcker panel is operating under a killer constraint. They
were told not to consider anything that would increase taxes for those making
less than $250,000 a year. Once you do that, you rule out any fundamental tax

The bipartisan tax reform panel that I worked on in 2005
came up with a plan that would have broadened and simplified the tax system
considerably. We proposed a new family and work credit to replace the
cumbersome hodgepodge of work and family subsidies in the code now. We also
eliminated the alternative minimum tax and kept rates no higher than they are
today. To do that, we eliminated numerous individual and business tax
preferences. I think those ideas still hold up well.

Unfortunately, our report came out right after Hurricane
Katrina and not long after President Bush had tried to do something with Social
Security and failed. There was no political will to go forward. The lesson is
that any real tax reform needs a president who is going to push and provide

Is a value-added tax (VAT) likely to be part of any package?

It’s quite possible that once we start exploring
all the possible ways of raising revenue, we will come to the conclusion that we
may need to adopt a value added tax. Economists agree that it is a very
efficient tax. We may just have to give up being the only [major industrialized]
country that doesn’t have a VAT.

Everyone would pay the VAT. Would that conflict with President Obama’s
pledge not to raise taxes on anyone except the top 5 percent of earners?

I think President Obama has the political capital to take
a deep breath and say, “When I was running for office, we were in a
different fiscal situation. But things have changed, and everyone is going to
have to chip in if we want to have the government services that have been
demanded.” (See our other story, “VAT: New Tax Coming Soon?”)

The last big tax reform was in 1986, during the Reagan administration. Is
there enough common ground today among Democrats and Republicans to make
something happen?

Everyone agrees that the tax code has problems that need
to be addressed. Everyone agrees that Americans deserve a better tax system.
That is the common ground.

In policy terms, I think there is a general belief that
the tax base should be broader; that we need to examine all of the special
deductions and exemptions and take a crack at eliminating many of them; and
that both corporate and income-tax rates could go lower. That was essentially
the result of the 1986 reforms. So I believe that there is a quite a lot that
both parties can agree on.

More on MoneyWatch:

  • What's Next for Taxes
  • Top 5 Tax Changes in Your Future
  • VAT: New Tax Coming Soon?

  • href="">Be Prepared: Your Taxes Will Get Higher

  • href="">What’s Your Tax Bracket?

  • href="">Audit Red Flags: 8 Things Not to Do
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