Little Agreement on Tax Reform

“Tax reform” is often mumbled with sagacious nodding of the head, as if all agree that it must be done.  But each of us seems to have different reforms in mind.  While many will agree that changes should produce the same or less tax revenue than today, there is no shortage of proposals.  The tax reform proposals seem to fit into three major themes.

Tax Simplification.  Over decades, our tax code became a mish-mash of stand-alone ideas that Congress was able to pass.  The current code needs specialized accounting skill to stay in compliance.  Most of us prefer a leaner code without the greasy buildup of political pork.   Simplification is fine but watch out since many who extoll a “clean slate” use that as cover for radical change proposals, such as a flat rate income tax or a national sales tax in lieu of income tax.

Tax Provisions to Invigorate the Economy.  Job creation and economic stimulus are popular tasks to assign to the tax code.  Tax credits and deductions are today structured to accelerate investment and hiring.  They can also foster innovations and productivity leading to higher labor wages, and when the height of the tax rates steps are shortened, more money is left for consumer spending or saving.

Tax Provisions to Reduce Income Disparity.  Reducing the after-tax income of high wage individuals is a populist surrogate for increasing the income of low wage earners.  Higher taxes are imposed by steepening the tax rate curve, limiting deductions, and sharpening the Alternative Minimum Tax bite.  Higher real earnings could flow to low wage earners through increases in the earned income credit – but that forgoes the schadenfreude of punishing the rich.    

Many of the so-called rich are small businesses whose owners file an IRS 1040 form.  These people may pay contractors and make substantial investment in their business, but they choose to be taxed once – not once as a business then again as an individual.

Simplification, invigorating the economy, and reducing income disparity are worthy themes.  However, the pursuit of each is to a great degree at odds with the others.  In today’s climate of political antipathy, it is highly unlikely that Congress and the White House will be able to agree on tax reforms for individuals earlier than in 2017.  There is too much bitter resentment toward high income individuals as evidenced by the massive federal tax increases on investment income that became effective in early 2014.

For businesses, it may be a little different.  Large corporations often conduct business in foreign countries.  To bring profits back to the U.S. they face U.S. taxes that are often substantially higher than the tax in the country where it was earned.  In fact, the top U.S., state and local rate is 39.2% versus an average top rate of 27.8% in other countries.  The stockpile of U.S. corporate cash abroad was $1.45 trillion in 2013.  If those profits are used to invest abroad, the U.S. misses out on the jobs stimulus they could provide in the U.S.  

In their unquenchable thirst for more funds to spend, some politicians would prefer that businesses be obligated to repatriate their profits and subject them to U.S. taxes.  That dampens new foreign investments since they would face the same burden.  Many politicians understand that companies see more attractive options than repatriating the funds for brutal taxation.  Resolution of this conflict will require the U.S. to become competitive in international corporate tax rates.  Our tax rates do not need to be the lowest – they just need to be calibrated so that US repatriation and investment is a rational choice for profitable companies.  

There is a chance that the Congress and the White House may agree on corporate taxes applied to foreign income, because attitudes toward corporate earnings are less crazed than attitudes toward high income individuals.  Corporate profits are correctly and widely seen as investments that potentially create jobs, unlike earnings of the undeserving rich.  With luck, this self-defeating attitude toward successful Americans will cease after 2017.

Alan Daley is a retired businessman who writes for The American Consumer Institute Center for Citizen Research

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