A daunting triple alliance: will the Federal government ever display enough courage—or know-how—to contain the triple-headed beast of Social Security, Medicare, and Income Tax reform?

NOW THAT THE ELECTION campaigns are well behind us, we can look at the economy in a more dispassionate way. In that light, 2004, as widely anticipated, registered the strongest economic performance in quite a while. The combination of tour percent growth, two percent inflation, and rising employment does not quite qualify last year for the Guinness Book of World Records, but there is little reason to don sackcloth and ashes.

Of course, when assessing 2005 and beyond, there is no shortage of economic problems facing the nation. Policymakers in Washington are dealing with a variety of challenges. Let us start with the announced policy agenda of the Bush Administration. As in the President's first term, the emphasis is on fiscal policy, especially the revenue side of the budget. Attention is being given to reforming the Federal tax structure by shifting the tax base from income to consumption. Such a change has been underway in other industrialized nations for several decades. Nevertheless, it still is a controversial idea here at home.

Promoting savings via tax reform would be a fundamental, albeit partial, response to the desire to reduce the huge current account deficit by curtailing national dependence on foreign funds. Increasing savings, however, is not exactly a bumper sticker issue. Yet, focusing on this objective would be far more constructive than yet another harangue about outsourcing.

We must acknowledge several constraints that have been imposed on reform proposals. The first is that they be revenue-neutral. That is Beltway lingo for raising the same amount of revenue as the existing tax system. At the technical level, that is the standard way to evaluate alternative tax proposals. At a time of large budget deficits, that requirement also makes good sense on substantive grounds. It seems likely that we will have to forego the luxury of sweetening future tax reforms with new tax cuts.

That view is reinforced by the other revenue-restricting constraints being imposed on tax reformers. The most compelling is to make permanent the large, but temporary, tax reductions recently enacted. A related issue is extending the short-term reduction of the increasingly painful Alternative Minimum Tax, which expires at the end of 2005. Finally, let's mention the scheduled restoration of the full estate tax in 2011. Any constructive response to that situation will reduce the revenue base as well.

The President has appointed a Commission on Tax Reform to deal with this cluster of issues. At the same time, the Office of Management and Budget is performing its annual ritual of showing how the Administration in office is going to reduce future deficits. Given the demonstrated reluctance of the White House to veto spending bills, an environment of fiscal concern surrounds the work of the Commission. It is hard to keep a straight face when examining the recently enacted appropriation bills. They cover such high priorities as the Rock and Roll Hall of Fame, the Please Touch Museum, and research on blueberries, grapes, and jointed goatgrass. The total of such "ear-marked" spending comes to $16,000,000,000, an all-time high for pork.

As it proceeds, the Tax Reform Commission will have to deal with several basic questions. The most fundamental is whether to continue with the current trend of incremental change in the tax structure or to substitute a new revenue collection system.

In this regard, the Flat Tax developed by Stanford University economists Robert Hall and Al Rabushka, as well as the USA Tax proposed by former Sen. Sam Nunn (D.-Ga.) and Sen. Pete Domenici (R.-N.M.), each retain the notion of an annual tax return to be filed with the IRS. The proposals diminish or eliminate the tax burden on savings and lessen the complexity of the existing Internal Revenue Code--but to very different degrees and in strikingly different ways. The USA Tax has a special claim. It squares the policy circle--by conjuring up that wonder of fiscal wonders, a progressive consumption tax. Of course, it does so at the expense of foregoing some simplicity.

The public view of consumption taxation, however, is embodied in the notion of a national sales tax. Much of the current congressional interest in tax reform focuses on this approach. On the surface, a sales tax has considerable appeal. First of all, it is a very familiar concept and easy to understand. Also, there is the added attraction that the individual voter (taxpayer) no longer will be dealing with the IRS. The seller would collect the tax at the point of purchase. Moreover, like the European-style value-added tax, levies likely can be rebated on exports and imposed on imports without violating World Trade Organization rulings.

Of course, there are a few complications. The IRS will have to establish a new sales tax collection system in order to receive the proceeds from the sellers of goods and services. In the case of Federal excise taxes, some of these sellers simultaneously will be collecting another set of sales taxes for the Feds. Meanwhile, employers also will be collecting Social Security and Medicare taxes for the Federal government.