Tax code needs lower rates, broader base

Washington is again engaged in a tax debate. Each year, lobbyists and political contributors persuade politicians to insert new loopholes. As a result, the four million-word, 74,000-page Internal Revenue tax code is riddled with special interest provisions.

The mind-boggling complexity of the tax code is a money machine for lawyers, accountants, and huge corporations. Americans spend six billion hours and $10 billion annually preparing and filing their income tax returns.

This is the exact opposite of the broad tax base with low rates that would best serve the American people. A broad-based income tax is one in which whatever you earn is taxable. Taxpayers lose their deductions but get a simpler and fairer code, and much lower rates. If the tax rate is low, economic decisions will be based on business and personal considerations, not tax implications.

In April, the Trump administration released a broad outline of proposed tax changes that would reduce the corporate tax rate from 35 percent to 15 percent and include a one-time tax of 10 percent on overseas profits designed to bring the estimated $2.6 trillion stashed abroad back to be invested in the United States.

The plan cuts individual tax rates and reduces seven brackets to three. The top rate falls to 35 percent from 39.6 percent and the lowest rate starts at 10 percent. The plan also doubles standard deductions. It does not specify to which income levels each bracket would apply. It also eliminates the federal income tax deduction for state and local taxes, except for mortgage interest and charitable contributions.

The Trump administration promises that 3 percent annual GDP growth would make up for potential revenue losses. On the other side, Democrats argue that the White House and Republicans would exacerbate income and wealth inequalities by throwing money at the rich at the expense of the middle class.

Republican deficit hawks argue the plan will add trillions to the national debt over the next decade. They argue that deficit-financed tax cuts usually impede growth. For example, increased government borrowing drives up interest rates and reduces the financing available to the private sector. They want revenue neutral reform under which tax cuts are offset by closing loopholes.

Among the risks is that Americans will not spend the money they get from tax breaks, instead saving it or using it to pay down debt. Corporations could also decide to use the money to increase dividends, juice up executive pay and generate a fresh wave of mergers and acquisitions. 

Tax cuts are often confused with tax reform, which restructures the code to make it simpler, fairer, and more efficient. Cuts are easier than reform, which is a tough sell because there are winners and losers.

The United States needs a completely new tax code; one that reduces rates; broadens the tax base; and eliminates back door spending in the form of exemptions, exclusions and tax credits.

This kind of reform was accomplished in the Tax Reform Act of 1986, which reduced the top marginal rate for individual taxpayers from 50 percent to 28 percent, eliminated about $100 billion in loopholes, and taxed labor and capital at the same rate. It also cut the basic corporate tax rate from 48 percent to 34 percent and eliminated many corporate deductions.

But since then lobbyists and political contributors have succeeded at restoring tax breaks, which narrowed the base. As a result, rates had to increase to generate the same amount of revenue.

What needs to happen is clear, but don’t hold your breath waiting for it to pass. Congress and the White House are distracted by the investigation into possible ties between former Trump aides and Russia, and the Senate healthcare debate could drag on through the summer.

Meanwhile, momentum for major tax cuts or major infrastructure investments has stalled. This time next year, leaders in Washington will likely still be arguing about tax reform.

Originally published: June 10, 2017

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