The Fate of Tax Reform Depends on the Tea Party

A new day is dawning, and on Capitol Hill, conservatives must make a choice. Will they follow the easy path of politics as usual, or will they practice what they preach and adhere to their core principles? The high-profile controversy over earmarks in appropriations bills is a prime example of this struggle. Unfortunately -- and cynics will say predictably -- the earmark ban went down to defeat in the Senate. The next battleground where parochial interests will square off against ideological purity is tax policy. The outcome could be the linchpin for determining if surging hopes for tax reform will be realized or if they will just fade away.

Under the traditional Republican view, all tax cuts are good and all tax increases are bad, period. This is a time-tested winning electoral strategy. There is tremendous value in allowing very few exceptions to the rule, because of the need to preserve the Republican brand as the party of low taxes. Under this view, tax expenditures are welcome because they are tax cuts.

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The alternative view is the diametric opposite. The case was nicely laid out by former Reagan economic adviser Martin Feldstein in a July 20 Wall Street Journal op-ed: "Cutting tax expenditures is really the best way to reduce government spending." Feldstein's logic is impeccable. Government can reward favored constituencies and interfere with the economy just as easily through the tax code as through direct spending. Therefore, those who oppose big government must be tax reformers.

Although the Tea Party is more famous for passion than for logic, it has gravitated to views like Feldstein's. According to the Tea Party, the tax laws should be simplified. (Under item no. 4 of the Tea Party's "Contract From America," the code would be no longer than the 4,543 words of the U.S. Constitution.) Government subsidies for special interests should be eliminated. And government should be downsized to only the most essential functions. The tax code should be purged of targeted tax breaks. Tax expenditures are tax earmarks.

It would be easy to dismiss Tea Party tax policy as political naïvete. But even before the Tea Party newcomers got the keys to their wood-paneled offices on Capitol Hill, their influence was being felt on the House and Senate floors. Amidst all the hubbub of the lame-duck session, a pitched $5 billion battle was being fought over a one-year extension of ethanol tax credits.

Alcohol Problem

On one side were the farm state legislators trying to keep corn prices high and the profits flowing from ethanol distilleries all over the Midwest. Their ringleader was Senate Finance Committee ranking minority member Chuck Grassley, R-Iowa, who was just reelected to his sixth term with 64.5 percent of the vote. He cosponsored legislation with Senate Budget Committee Chair Kent Conrad, D-N.D., to extend the credit, along with tariffs on imported ethanol, for five years. (Ironically, both Grassley and Conrad have reputations as fiscal hawks.) Working behind the scenes were the lobbyists for agri-business giant Archer Daniels Midland, which produces 1 billion gallons of ethanol annually, and the Iowa-based American Future Fund, backed by Bruce Rastetter, a co-founder of one of the nation's larger ethanol companies, Hawkeye Energy Holdings (The New York Times, Oct. 11, 2010).

Opposing the subsidies were the usual suspects: oil interests; legislators from the coasts who preferred spending money on their own constituents; all parts of the food industry that want low corn prices; and environmentalists who had calculated that, mile-for-mile, ethanol is responsible for more greenhouse gas emissions than gasoline. A sprinkling of perennial reformers also opposed the credits. This last group used to include Sen. John McCain, R-Ariz. But in his 2008 bid for the Republican presidential nomination, McCain flip-flopped on the issue. "I support ethanol, and I think it is a vital, a vital alternative energy source not only because of our dependency on foreign oil, but its greenhouse gas reduction effects," he told Iowans in August 2008.

But the anti-ethanol movement has more than compensated for its loss of McCain's support by gaining the backing of the Tea Party. . . .

Could this grass-roots movement derail the ethanol juggernaut? Immediately following the election, there was serious speculation about cutbacks in the ethanol credit (Bloomberg, Nov. 3, 2010). Two senators closely allied with the Tea Party, Jim DeMint of South Carolina and Tom Coburn of Oklahoma, were particularly vocal (The Washington Post, Nov. 22, 2010). The price of ethanol futures began to tumble (Bloomberg, Dec. 2, 2010). . . .

But in the end, both the traders and lobbyists were too pessimistic. It quickly became apparent that the tax bill considered during the lame-duck session would extend the full ethanol credit until the end of 2011.

Litmus Test for 2012

What can we learn from the latest ethanol episode? We have learned that the Tea Party -- if it remains true to its principles -- can be an important ally in the fight to eliminate tax expenditures, the toughest part of any tax reform effort. But we have also learned that while it is highly influential, the Tea Party does not yet have enough power to force fundamental change on big money issues.

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The ethanol credit will expire at the end of 2011, setting the stage for another high-profile battle just before the race for the Republican presidential nomination goes into high gear. The Tea Party will be watching closely. . . .

And so it will also be a litmus test for tax reform. If the Tea Party movement does not deliver Republicans from the temptation of doling out tax subsidies, it is hard to see what other political force can transform tax reform from dream to reality. Tax reform does not need more study. It needs an injection of passion.

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View TaxAnalysts' Martin A. Sullivan's opinion in its entirety on TAX.com.

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