If policymakers craft a tax reform bill that’s truly deficit neutral — such as by scaling back their desired rate cuts and making sufficient changes in tax expenditures to offset the cost — it would create a serious problem of its own by paralyzing efforts to reach a long-term deficit reduction agreement, possibly for a number of years.
If policymakers enact deficit-neutral tax reform, they will have made the politically possible changes in tax expenditures while locking in lower tax rates. Because policymakers would have nowhere else to go on the tax expenditure front, revenue would likely be effectively off the table for the further deficit reduction that — despite the fiscal improvement in recent years — is still needed to put the nation on a sustainable long-term path.
The fiscal ramifications would extend beyond revenue. Politically speaking, any large long-term budget agreement will likely include both reductions in mandatory spending (for example, in Medicare) and additional revenue. Those who oppose mandatory spending cuts would almost certainly relent only if the proponents of such cuts agree to team them with tax increases. So, deficit-neutral tax reform would likely take such spending cuts off the table as well, leaving policymakers nowhere to turn for more mid-term and long-term deficit reduction.
In addition, it would likely extend the sequester:
Sequestration took effect this spring and will almost certainly remain in effect for the rest of the current fiscal year. Moving forward, the political path to ending it remains the same — replacing it with a broad, balanced plan of both more revenues and savings in mandatory programs that help address the long-term budget challenge.
Deficit-neutral tax reform that claims the politically achievable savings from scaling back tax expenditures and locks in lower tax rates makes that more balanced deal much harder for policymakers to craft. The harder it is from them to craft it, the longer that sequestration will likely remain in effect.