Fiscal Reform: The Impossible Compromise

Though imperfect and incomplete, the fiscal reform of 1986 remains a perfect model of its type for many Americans. It also reminds us of a bygone era when the [system of] “checks and balances” of American institutions was synonymous with compromise and deliberation — not blockage or systematic sabotage, as is the case today.

The Tax Reform Act of 1986 (TRA86) was possible for at least two reasons. The first was the theoretical rupture from the intellectual legacy of postwar economic models. After two oil crises, a deceleration in activity and, above all, a tough inflation that lasted the whole of the 1970s, the theories became obsolete. The search for a new model (or, correctly, a return to non-Keynesian theories) forced itself as much on the Democrats as it did the Republicans.

The best example was the implementation of the Economic Recovery Tax Act in 1981. Its key measures included decreasing household tax rates by 23 percent over three years (with the maximum marginal rate going from 70 to 50 percent) and the indexation of tax bracket inflation (planned for 1985).

In effect, between the end of the 1960s and the beginning of the 1980s, the great inflation of the ‘70s progressively displaced modest-income households from the higher tax brackets with a near doubling of the tax rate, feeding a resentment toward the unjust and unbearable fiscal system, as much within the Democratic electorate as the Republican one.

The lowered tax rate was inspired by the proponents of supply-side economics (primarily Laffer), for whom the drop in taxes would be self-financed by the growth of associated activity. The hypothesis that a decrease in income tax would increase the incentive to work (sic) and generate higher revenues has not been confirmed. The subsequent growth in deficits explains the (modest) increases in taxes that followed in 1982, 1983 and 1984 — increases that did not succeed in making up for public deficit.

The underlying idea of the 1986 reform was to reduce marginal rates to 28 percent, in exchange for multiple provisions (such as “expenditure taxes” and “sheltered investments”) and an increase in the tax base. To avoid being a “gift” for the rich, the reform also targeted low-income [households] by proposing personal exemptions. The extremely high marginal rate (70 percent in 1981, 50 percent in 1986 for the richest), coupled with the proliferation of schemes and accounting tricks used to reduce the effective tax rate, resulted in a de-incentivizing effect.

The second reason was the search for and rapid acquisition of public consensus. What started as a response to a Democratic electoral offensive in the 1984 presidential election was finally translated — once Reagan was re-elected — into the greatest example of cooperation the U.S. had seen in 30 years. It should be well understood that since the beginning of the 1980s, the two sides have fiercely battled over the subject of tax cuts.

The Democrats sought to index tax brackets and eliminate exemptions, which were perceived as unjust, while the Republicans were aiming for an excessive level of marginal tax rates. The two sides agreed [that there was an] inefficient allocation of resources generated from multiple provisions of the [tax] code. The combination of greater equity and greater efficiency in the allocation of resources would allow for a political consensus regarding the implementation of the 1986 Tax Reform Act.

The success of this reform should also be attributed to two men: President Ronald Reagan and Democratic Speaker of the House of Representatives Thomas “Tip” O’Neill. Despite their political disagreements, [the two men] negotiated discretely and gave pledges toward a bipartisan agreement.

The convergence of interests (necessary in order to reform the fiscal system and decrease taxes, in the absence of similar beliefs) and respect for institutions (such as the bipartisan agreement and compromise) were key to the success of TRA86.

Today, dysfunctional institutions suggest that America is far from such a reform. We can sum up the situation in a few lines: an ideological gulf between the two parties, a growing homogeneity of the political viewpoints of members from each party, electoral redistricting that does not favor changes in power, harmful external influences and a permanent electoral campaign ….

Another reason the 1986 reform was possible is because conservative Democrats represented over one-third of the Democratic Party in 1980 (compared with 10 percent today). The progressive disappearance of the “blue dogs” (in simple terms, centrist Democrats) illustrates the absence of a link between the two parties. Additionally, if several cases of sharp divisions between Republicans and Democrats exist in American history, rarely has the country combined such a polarization of the parties with such homogeneity within them.

In the last few years, the U.S. political landscape has come to look like a massive hostage situation. Ideological polarization explains the failures of Congress:

• Marginalization of committees that historically served to smooth over differences between the House and the Senate.

• Systematic refusal of negotiations with more and more “holds” (the drastic blocking of nominations; Republicans criticizing Obama for implementing his policy through agencies rather than through the passage of laws) and “filibusters” (the monopolization of debate that requires a large majority of 60 senators to stop it).

All this is not the result of any institutional innovation, just the logic of the rules of counter-powers pushed to the extreme. From now on, exceptional measures are the norm. Obama’s re-election changed nothing. There is:

• A major gulf between the political parties and a governmental system that leaves the majority with very little room for maneuvering. The rules of the majority favor inter-party coalitions and compromise — something the current divide between Democrats and Republicans does not allow.

• A strategy of extremes within each party that translates as a disregard for compromise, the viewpoints of the opposing camp being by nature [seen as] illegitimate. There are many reasons for this political polarization: the manipulation of electoral district boundaries around areas that contain a concentration of populations favorable to one or the other party, the “big sort” (the regrouping of communities, which is becoming more and more pronounced in residential areas), media bias and the financing of electoral campaigns, which accentuates ideological views and supports candidates at the extreme ends of the political spectrum.

It would be futile to believe that such an environment in America [would be conducive to a] repeat of the feat of 1986. This is as much unimaginable as it is strongly probable that Republicans will also win the Senate during midterm elections in November 2014.

Lessons to be learned elsewhere, particularly in France, are minimal. Not because there is common ground on the subject of fiscal reform, but rather because the parliamentary system gives more weight and a much greater responsibility to the majority.