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Tax reform: A task of Olympic difficulty

Now that the 2012 Olympics are over, it’s time to draw some lessons. Here’s an economic one: Tax reform is difficult to achieve and difficulty to maintain.

What? What’s the connection? Some of you may recall that, after American athletes began winning the gold, news outlets reported that prizes and medals would be taxable. This led to a legislative proposal to exempt them from taxation.

If we want to keep our current creaky and overgrown tax system, the proposal for the Olympians makes sense. Let’s add one more tax break, so that nothing will be due from these young men and women who worked so hard and represented their country so well.

But sometimes there are things we economists know, and we know them so well that we want to say, “Shut up and listen.” We’re much too polite for that, but this is one of these times. If you want a good tax system, you need the widest possible tax base and lowest tax rate for any given revenue-raising goal.

Exempting Olympic winnings illustrates all this so well. If you exempt Olympic winnings, why not the winnings of those who represent our nation in international music and art competitions? And if that, should the exemption apply when the international competition is held in the U.S.? And if that, shouldn’t we exempt winnings of athletes and artists and musicians in domestic competitions, not just international ones?

You see where this is going. The seemingly good idea of a tax break for Olympians then means more pages in the tax code — or arbitrarily excluding others who represent our country just as well and work just as hard. And: Every time you exclude some part of taxable income, you increase the rate that must be paid by everyone else, for any given amount of revenue raised.

Olympic winnings are a tiny part of overall taxable income. Other tax breaks are not. But the same principles applies. Take the home mortgage interest deduction, for example. It narrows the tax base, requiring pages and pages of regulations to implement (filled out your Schedule A worksheet? get your points right?). And in the end, it requires higher taxes on all of us, including renters with lower incomes than many of the beneficiaries, to raise the same amount of revenue.

Some people are worried that the rich pay too little in taxes. My worry is different: that the “wrong rich” pay too little in taxes: those who have vacation homes (yes, the interest on the mortgage is tax deductible); those who hire sharp accountants to structure their income as capital gains (taxed preferentially); well, the list goes on and on.

So let’s say that after the election, we get a good tax reform. This will mean an end to all those exclusions and preferences. We’ll tax everything at a lower rate. Having cleaned up the tax code, we will then dirty it up. Particular tax breaks will be proposed. Any one of them by itself will seem reasonable — reducing taxes for Olympic athletes, or for home owners, or for people who install solar panels. But, taken together, if added back into the tax code, they will get us right back where we are right now. At last count, the tax code had 73,608 pages.

Honor the Olympians? Great! But if we wanted a good tax system, that tax break and all the others like it would have to go.