Politically Thinking: Income tax emerges as a key issue

Fundamental reform of the income tax system may be high on the agendas of both President Obama and Gov.-elect Shumlin in 2011.

Congress has passed the compromise between President Obama and Senate Republicans that will extend Bush-era tax cuts for another two years for all taxpayers. The two-year extension will put tax issues at the center of the 2012 presidential campaign.

If Congress takes no action on tax rates in 2011 or 2012, the final weeks of Obama’s re-election campaign will be dominated by the same arguments we have seen for the last two weeks: whether or not to extend the Bush-era rates for those Americans with household incomes over $250,000. The combination of Republican control of the House and Democratic control of the Senate in the new Congress makes no action a likely outcome.

Obama has hinted in recent interviews that he would like to focus on tax reform rather than tax rates in the next two years. The president is seriously considering proposing a fundamental reform of the tax system in his State of the Union address early next year. Obama would use the expiration of the Bush-era rates at the end of 2012 as a deadline to force Congress to act.

The president would challenge Congress to replace the current income tax system, with its myriad of exemptions, deductions, credits, and preferences, with a new tax system that would have far fewer exemptions and lower rates. Focusing on tax reform would accomplish two goals for Obama. First, it would allow him to fight the tax battle on ground of his choosing, rather than on the Republicans’ ground of permanently extending the Bush-era rates for all Americans. Second, Obama could make the case, supported by most economists, that a reformed tax system would help economic growth by allowing individuals and businesses to make economic decisions based on their substantive merits rather than their tax consequences.

Here in Vermont, a blue-ribbon commission studying the state’s tax structure will submit its report in the next few weeks. The commission will likely recommend broadening the base of both the income and the sales taxes, and compensating for the broader tax bases by lowering both income and sales tax rates. The commission will argue that tax reform will make Vermont more competitive with other states, while continuing to raise sufficient revenue to support state government programs.

Gov.-elect Shumlin has stated, both during the campaign and since he was elected, that he generally supports the principles of expanding the tax base and lowering tax rates. Shumlin might very well make fundamental tax reform one of his high priorities for the 2011-2012 legislative biennium. Should Congress succeed in reforming the federal tax structure, the need for significant reform of Vermont’s tax system will become more urgent. Many of the definitions of income and preferences in Vermont’s tax system are closely based on federal law.

Any proposal for substantial tax reform, in either Washington or Montpelier, will be strongly opposed by those who benefit from the current system of exemptions and deductions. Among these organizations and institutions are the real estate industry, Wall Street, charitable organizations that rely on large donations, and corporations with foreign income. If Obama and Shumlin can present tax reform to the public as a change that will benefit average taxpayers at the expense of special interests, tax reform could turn out to be a winning issue for both the president and the governor in 2011 and 2012.

Eric L. Davis is professor emeritus of political science at Middlebury College.


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