Save the swamp?

"Drain the swamp" has the memorable rhetorical flourish the president so effectively uses.  It encompasses in three words the revulsion of his supporters to the accumulation of special interests he boldly seeks to undo.  We should not underestimate the challenge.

Reacting to the reduction or elimination of the mortgage interest deduction, the real estate lobby immediately sought to protect its part of the swamp.  Never mind that this sacred deduction to reward homeowners comes at the expense of those who rent and those who have paid off their mortgages.  Never mind that countries like Canada without the home interest deduction often have higher rates of home ownership.  Never mind that the deduction often benefits the wealthier taxpayers.

The real estate industry is just one of hundreds of special interests who will fight to protect their special privileges.

If the per capita cost of government is x, then every deduction, credit, and tax benefit awarded to one party comes at the expense of another.  The main function of lobbyists is to exploit their influence to get tax benefits for their clients.  They exist because of the basic principle of lobbying: focused benefits and dispersed costs.

The benefit to an industry or a specific company from specific legislation and regulation can be substantial, making the lobbyist's generous expense account easily justified.  The costs, however, are dispersed over millions of taxpayers and are too inconsequential per voter to justify spending political capital to oppose. 

The voices for tax cuts obscure the bigger issues of tax reform.  Rates matter, but so does consistency, simplicity, and permanence.  The variance of tax policy from one industry to another influences capital allocation in ways that cost us beyond the lower rates gifted to influential sectors.  The amount of money we spend just to comply with or to circumvent the tax code could be saved by a simplified plan without costing the Treasury a dime.  It could even increase revenue.  How much talent is wasted on tax issues that could be used on productive and innovative pursuits?  How much is spent on estate planning to avoid onerous taxes triggered only by a taxpayer's death?

And how much of any tax reform is neutered by the lack of any faith that the code will remain in place long enough to consider its implication?

I call the difference between the statutory rate and the actual rate the "special interest spread."  It is the difference between the official stated rate and the actual rate paid after deductions and credits.  True tax reform should seek to reduce this spread to zero. 

All tax cuts do not pay for themselves.  Laffer illustrates that depending on the point in the curve, tax cuts can generate more revenue, but it depends on the amount of the change, the original rate, and the specific tax.  Taxes on earned income are harder to avoid than on capital gains, where timing can be more easily exercised.  Productive activity can be influenced by many other friction costs such as regulation, inconsistency, and security. Spending and the debt cannot be ignored.

But there remains a great benefit to meaningful reform in the form of simplification.  The influence of the federal government is less because of its growth in size than because of its proxies in the private sector.  Nonprofits, state and local agencies, and special interests do the work of the federal government, and much of this is done through tax preferences and benefits.  These proxies will all be fighting to retain their part of the swamp. 

Taxes should be low and broad-based, as simple and as permanent as possible, while minimizing the "special interest spread" and the marginal rate.

Such a reform castrates much of the federal power over the economy, requiring the separation of operating revenue requirements from their desire to engineer and design social outcomes.  Any transition to such a system will not be equally shared, and there is no need to pretend otherwise.  Many who lose their mortgage deduction will make it up in lower rates, but some will not.  This is the problem with reforming complicated systems with an accumulation of special provisions.

The benefit to the economy, however, would be so strong that those who are comfortable in the swamp should not be allowed to derail it. 

Henry Oliner blogs at

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