Tough Choices on Tax Reform

Tough Choices on Tax ReformBoth parties agree the tax code needs changing, but how to do it will require hard work.

Budget & Tax  | Quick Takes
May 17, 2017  | By  | 6 min read

This week, the House Ways and Means Committee will hold its first hearing of this Congress on the prospect of comprehensive tax reform.

The hearing is focused on how tax reform can grow the economy and create jobs. Those goals, and the underlying fact that our current tax system is broken, are some of the very few things people across the political spectrum can agree upon.

After that, the areas of disagreement come fast and furious: What do we mean by growth? Would wage growth without gross domestic product growth be good for the economy? Is it even possible? Conversely, what kind of wage growth would yield meaningful growth in GDP? Exactly what kind of tax policies will produce the desired growth?

When President Donald Trump unveiled his one-page outline for tax reform, Treasury Secretary Steven Mnuchin said the growth spurred by those policies would pay for the rate reductions outlined by the administration. Even most conservative economists think this is close to impossible, and indeed, that tax cuts almost never pay for themselves. If we reform the tax code – by which I mean make permanent structural reforms to the code as opposed to a temporary fix which expires and must be extended – there are two likely outcomes.

The first option is that reforms will even out the playing field by eliminating many of the special interest tax breaks to pay for lower rates. That means that some people and companies that were paying less in taxes will pay more, and some people and companies that were paying more tax will pay less. It also means that a simplified, more rational code will lead to some increased growth.

The second possibility is that large tax cuts disguised as reform and reduced revenues are purportedly offset by optimistic growth projections. Under this option, the country will face significant long-term deficits, which in turn, will increase the already staggering nearly $20 trillion national debt. While it is likely obvious to people who have read some of my earlier pieces, I want to clarify: Taxpayers for Common Sense is not in favor of dramatically increasing the deficit and debt.

So what kind of reforms would yield growth and help meet our fiscal challenges? For many reforms, there are strong arguments coming from different interest groups. Take, for example, the proposal to adopt immediate expensing. What this means, in practice, is that large businesses that make big capital investments could write off all of the expense of those investments in the first year instead of taking the deduction as depreciation over time, as the current law requires. Proponents of this policy say that it would spur investment and create jobs, both among those who create large equipment and the businesses that purchase the equipment. Adopting this policy would require the elimination of interest expense deductions, or else some companies would benefit from a negative tax rate.

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Capital-intensive firms would be fine with this trade, but businesses that don’t invest in plants and equipment and rely more heavily on labor, such as retailers and the service industry, would not. So the debate leaves the policymakers trying to answer the question of which interest to favor, and whether they can afford to give everyone what they want. Offering an either-or approach is not really an option because it would drive revenue down even further than going one way or the other.

Similarly, there are arguments on all sides of the question of what to do about the tax treatment of international profits and operations. Everyone can agree that the current system has created incentives to park profits overseas and to create balance-sheet fictions of overseas operations for intellectual, property-driven industries and other large multinationals.

But what is the solution? Ending deferral, which simply prohibits companies from deferring the taxes they owe on those overseas earnings, is administratively easy and would raise enough revenue to lower corporate rates by as much as 10 points while remaining revenue neutral. Implementing a fully territorial system, favored by many businesses because it allows for flexibility in siting operations, would cost billions – making it harder to lower rates overall. And the border adjusted cash-flow tax outlined in the House majority’s proposal puts wholly domestic companies at a disadvantage to companies that export their products overseas.

All of this is to say that tax reform will take hard work, and that difficult choices will have to be made. I am thrilled to see that the House is starting with hearings – and I hope that this week’s hearing is the first of many. In order to make lasting changes to the tax code, we need to see honest math, principled leadership and compromise from both parties.

Originally published on October 27, 2017 in U.S. News & World Report

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