Tax Reform

 Why Abandon Revenue Neutral Tax Reform Now?

Republicans have taken a universally accepted need for tax reform (simpler, fairer) and used it to rally the country around their plans for tax cuts. Every proposed tax reform over the past 7 years (I count five.) has aimed to “Broaden the base. Lower the rates. Be revenue neutral.” The new Republican principle is “Broaden the base. Lower the rates. Increase our deficits.”

Defenders of these large unpaid-for tax cuts argue that we cannot bring down the deficit without higher growth. Tax cuts, however, have never generated enough growth to pay for themselves. After president Reagan cut income taxes, he later raised other taxes in response to rising deficits. His successor, George H.W. Bush, did the same. The ratio of debt to GDP (currently 77%) is now more than twice what it was in 1981. Meanwhile, taxes collected as a percentage of GDP are lower today than in 1981 (17.3% vs 19.1%). The party that shut down the government in 2011 by refusing to raise the debt ceiling, now no longer believes deficits matter.

Republicans want to greatly increase defense and infrastructure spending while our country is also dealing with several natural disasters. And their plan is to lower revenues? We all want and deserve a simpler, fairer tax code. However, the Republican plan is a very, big roll of the dice.

Do Not Fix Deficits Created By Tax Cuts With Cuts To Social Security

As soon as the Senate passed their tax bill, there were already Republicans saying “next we need to go after out-of-control entitlements”. There do need to be reforms to Social Security. But those reforms are needed to make Social Security sustainable, not to off set deficits created by Republican tax cuts.

Republicans should not object to bringing the amount of income subject to FICA taxes in line with the Reagan/Greenspan reforms of 1983. Those reforms were based on FICA taxes paid on 90% of our country’s income. Presently, FICA taxes are only collected on 85% of our nation’s income. This means raising the caps on income taxed for Social Security faster than the CPI rate. (Estimates are perhaps $190,000 by 2020.) Other responsible reforms include a lower percent of lifetime earnings paid out to high income earners and increasing the retirement age (again) to 69 by 2075.

A Revenue Neutral Corporate Tax Reform

U.S. corporate tax rates need to be lower in order for U.S. corporations to be globally competitive and to keep and attract global corporations to our country. However, the Republican approach shifts part of the current corporate tax burden to individuals and increases our deficits. The reduced corporate tax burden should, rather, be shifted to corporate share holders. This approach makes corporate tax reform almost revenue neutral, eliminating much of the pressure to recover revenue from the individual tax system or widen the deficit. It also eliminates much of the rationale for the very complicated Republican proposal for “pass through” businesses.

This reform cuts the corporate tax rate to 15% and ends the preferential treatment of capital gains and dividends. Dividends paid to a shareholder would now be ordinary income. The share holder would receive a tax credit reflecting their share of taxes paid at the corporate level. This finally eliminates any complaint of double taxation of dividends.

In addition to being taxed as ordinary income, capital gains would move to a mark-to-market system where gains or loses are booked and taxed on a year to year basis. To reduce disproportionate compliance burdens, small asset holders would be exempt from the mark-to-market approach. This is not unusual or difficult paperwork. My commodities futures account is automatically valued at year’s end and I book the gains or loses. However, this would be a very big change.

I do have a reservation about paying taxes on unrealized gains. Where is the money for the taxes supposed to come from? Also, I see these capital gains reforms as largely applying to equities. There is still a rationale for treating real estate preferentially. Real estate pays annual property taxes that equities do not and a part of any gain in long held properties acures from inflation.

This approach eliminates the incentive for multinationals to stash profits overseas. Foreign capital would be more likely to be invested in the U.S. Economic considerations rather than tax advantages would be more likely to shape business decisions. Some schemes to portray ordinary income as capital gains would be gone.

In my mind, one of the biggest arguments for this tax reform is that it is a bipartisan plan to cut corporate taxes. It is the combined product of the Tax Policy Center (progressive) and the American Enterprise Institute (conservative). I agree with Senator Ron Wyden (D-OR) who says that for any “big policy change to be successful, you need to have bipartisan buy-in.” We need stability and predictability in our tax code. That is best achieved with bipartisan agreements.

2010 Simpson/Bowles Plan

The Simpson/Bowles tax reform /deficit reduction plan still remains the gold standard in approaches to tax reform and deficit reduction. Again, the fact that it was a bipartisan effort (equally hated by each party) signaled its likelihood of ongoing support had it been adopted. It ended many deductions and cut tax rates. Its spending cuts seem almost draconian today: It used a chained CPI, cut military spending, increased the motors fuel tax,…. It remains a picture of the tough choices that face us if we are serious about reforming the tax code and fighting deficits.

Carried Interest

I can’t help but comment on the fact that “carried interest” survived the Republican tax reforms. President Trump and others had vowed to end it. It is an indicator, to me, that this is not the comprehensive, middle class friendly tax reform Republicans claim it to be. Brokers who construct portfolios for investors are paid on a commission basis. If their investments do well , they are paid more. However, carried interest lets them treat their commission as capital gains instead of ordinary income – and pay less tax. Does a real estate broker get to treat his or her sales commissions as capital gains?