Tax Reform

1. The Basic Tax Code

 

At the risk of oversimplifying, everyone knows what we need to do to address the deficit: We need to cut spending, increase revenues, and reform the tax code.  We know what we need to do – lawmakers just can’t get it done.

 

The Bowles-Simpson deficit commission modeled the framework for ending the tax code’s myriad loopholes, tax credits, and deductions while lowering tax rates – including corporate rates.  This broadens the tax base, increases confidence and predictability in the tax code, reduces compliance costs, and is thereby stimulating to growth.  What, if any, deductions and credits to keep would be the battle.  Special interests would abound.

 

There are some, seemingly, very defensible deductions.  (e.g. education and child care credits)  You have to do the hard work of looking at each and do the best cost/benefit analysis you can.  For my part, as I see things now, I would, for example, eliminate the mortgage interest deduction and health care benefits would be taxed.  I would keep deductions for charitable contributions and contributions to retirement accounts until they are withdrawn.

 

To help address our increasing deficits, these reforms should incorporate revenue increases – scored on a static basis, not a dynamic basis. (If reforms produce an economic boost as some want to promise, that’s a bonus.  But you don’t bet the farm on it.)  The outcome of the reforms should also be progressive.  Even former Bush advisor, Glenn Hubbard, endorsed the need for progressivity in commenting on the debt ceiling negotiations.  He stated that there should have been “a revenue contribution, structured to fall mainly on the well to do.”

 

2. Capital Gains Taxes

 

In the context of our current tax structure, I support ending the Bush tax cuts on capital gains. That returns rates to 20% on long term gains, 18% on investments beyond 5 years. The two lowest tax brackets should continue owing no taxes on capital gains. I would index the basis to inflation for capital gains on investments beyond 5 years.

 

Many people fervently argue that cutting or eliminating taxes on capital gains iskey to keeping capital flowing to investments in our economy. A frequently cited case in point is the dramatic 1978 cut in the capital gains rate from 49% to 25% – resulting in an apparent increase in investment capital judging from the equities market. Even to me as a layman, a 49% tax rate on investment income seems to be a significant disincentive. I would hope that a 50% decrease in the tax rate would have a significant positive effect in 1978.

 

But we are at 15% today, not 49% – historically very low. Further reductions from here would likely face the prospect of diminishing returns or no returns. Yes, the Bush tax cuts on capital gains in 2003 were followed by increased economic activity. In retrospect, though, we see that economic activity was the growing housing bubble. Also, we are not experiencing a shortage of investment capital in our present situation. This may, in fact, be a unique window of opportunity to raise capital gains tax rates without significant negative side effects. Our deficits are dire enough that increased revenue needs to be part of the solution. We have to pick our poison.

 

With the capital gains tax, there is also the issue of an equitable tax system. Most conservatives prefer not to talk about this. Bringing it up is sometimes painted as “class warfare”. But some conservatives do broach the subject. In 1985 President Ronald Reagan rhetorically asked a crowd, “Do you think the millionaire ought to pay more in taxes than the bus driver or less?” More recently, in his daily radio commentary, conservative Republican, the late Chuck Colson, recently echoed the late president’s question, “Should a hedge fund manager have a lower tax rate than a truck driver?” President Reagan was referring to closing corporate tax loopholes and raising corporate tax rates which he did in 1986. Mr. Colson was referring to capital gains tax rates.

 

For a variety of reasons there should be preferential treatment for capital gains but I believe it is appropriate to rebalance these rates. Dividends have historically been treated the similarly and I don’t suggest to change that. But I have never felt that capital gains had the same issue with double taxation that dividends do.

 

3. VAT (Value Added Tax)

 

A value added tax is tax levied at each stage of a product’s manufacturing where “value is added”. I do not support any form of a VAT.  First, it is a brand new form of taxation. Second, it is largely a hidden tax. The taxes we pay should always be open and transparent. Third, VAT is a regressive flat tax.

 

Surprisingly, a VAT is finding its way into many Republican fiscal proposals. Former candidate for president Mitt Romney refused to rule out a VAT. In Herman Cain’s 9-9-9 tax plan, that final 9 was a VAT.  Rep. Paul Ryan’s “Roadmap” plan includes a VAT, where it helps finance other tax cuts.

 

4. Flat Tax

 

No, No, No, No . What are people thinking that propose a flat tax? The selling points are that it is fairer and simpler. It is not fairer to the person who earns $30,000 to pay the same rate as the person making $230,000. If it is considered to be simpler because it ends all tax credits and deductions, that is simpler. But you don’t need a single rate system to end those. Just end them. The only thing simpler about a flat tax is that you don’t have to do all that hard work of turning to the tax tables.

 

5. Corporate Taxes

 

The U.S. corporate tax rate is one of this world’s highest. It is a disincentive to conduct business in the United States. It is a disincentive to bring profits earned overseas into the United States.

 

This high tax rate is also a strong incentive for corporate tax avoidance. Many, if not most, global corporations based in the U.S. pay a much lower effective tax rate than 35%. Aside from a secret Swiss bank account, much avoidance is legal. It is possible for a company to have almost 100% of its sales here in the U.S., almost 100% of its employees in the U.S., be based in New York City, and have most of its profits show up overseas, thereby greatly reducing their taxes paid.

 

There are many reasons companies cite business and manufacturing overseas. More beneficial tax treatment should never be one of them.

 

I support lowering the corporate tax rate and eliminating tax credits and loop holes with the goal that the reforms be close to revenue neutral. At present, each percentage point we lower the corporate tax rate will cost the government $12 billion. Current estimates are the government loses $75 billion each year through corporate tax avoidance.

 

I do not support a “tax holiday” where corporations are free to repatriate off shore profits for little or no tax. The last tax holiday was 2004. Corporations paid 5 ¼% on repatriated profits. Most of that money went to repurchasing company stock and some to CEO bonuses. Little hiring or investment resulted.