The Best and Worst Ideas for Tax Reform
Tax Day is upon us, but the reality is that America's current tax code is a millstone around the necks of families year-round. It punishes employers who choose to open businesses in America. It stacks the deck against middle-class families with children who are trying to make ends meet. It penalizes the poor who enter the workforce with effective marginal rates that would make Karl Marx blush.
No wonder politicians of all stripes say they want tax reform. Yet some tax reform ideas are better than others. In honor of Tax Day, here are three of the best and worst reforms under discussion.
Three Good Tax Reform Ideas
1. Full business expensing. Typically, businesses deduct expenses from their revenue when calculating their taxes. Businesses deduct the wages they pay and the office supplies they buy.
With some exceptions, however, businesses cannot immediately deduct the purchase of business equipment. For example, if a business purchases a computer, it likely cannot write off the full cost against its income. Instead, it must deduct the computer over six calendar years in a process known as "depreciation."
As a result, investing in new equipment becomes more expensive. Businesses buy less equipment, which makes them less efficient and means fewer sales for those who make the equipment.
Policymakers should scrap the current system and instead allow businesses to deduct the full amount of their investments in the first year, also known as full business expensing. A study by the Tax Foundation found that moving to full expensing would raise wages by 4.36 percent and create 885,300 jobs.
2. Unified and expanded child tax credits. The current tax code includes several child tax benefits: the dependent exemption, the child tax credit, the additional child credit, the earned income tax credit, the head-of-household filing status, and others. These well-intentioned provisions interact imperfectly, and consequently, working-poor families experience a high error rate with their tax filings.
We should unify all existing child tax benefits into a single, easy-to-understand child credit. The simplified credit should be more generous to working families with children than the current credit, preferential toward the working poor, and earned only by the middle class and below.
3. Smart payroll-tax reform. The largest tax most Americans pay is the FICA tax — the Social Security and Medicare payroll tax. Withheld from wages and matched by employers, the tax is indiscriminate, hitting young and old, rich and poor, single and married.
Here are two reforms to make the payroll tax more sensible. First, exempt working seniors from the payroll tax. After all, they have spent a lifetime paying FICA taxes, and most are drawing Social Security and Medicare benefits. Not only would over 4 million working seniors — many of them low-income — benefit from this change, but the tax cut would encourage enough seniors to stay in the workforce that income-tax revenue would offset three-quarters of the lost revenue.
Second, exempt the first $10,000 or $15,000 of wages from the FICA tax. This would help the poor transition into the workforce without facing staggering marginal tax rates. It would also encourage businesses to hire, since they would benefit from the lower taxes as well.
Three Bad Tax Reform Ideas
1. Bernie Sanders' high marginal rates. Sanders has proposed what may be the most anti-growth tax plan ever. He would hike the payroll tax, raise marginal income-tax rates all the way to 52 percent, and retain the 3.8 percent surtax, which, in combination with his payroll-tax hike, would result in marginal tax rates approaching 70 percent. He would increase the capital-gains tax to the same stratospheric levels and impose a financial-transactions tax. The Tax Foundation reported that Sanders' tax plan would lead to 6 million fewer full-time equivalent jobs.
2. Tax hike on "carried interest." This tax increase, a favorite of liberals, is in President Obama's budget as well as Clinton's and Sanders' plans. While advertised as a tax on Wall Street fat cats, in reality it punishes the very individuals who help turn around failing companies or generate returns for pensions, colleges, and charities. It would tax the capital gain that a managing investment partner earns at ordinary income tax rates, rather than the current lower capital-gains rate.
For example, say five people come together to save a failing company; four provide the money, and the fifth manages the company. Under this proposed tax increase, if they are successful and sell the company, the four who provided the capital will pay a tax rate that is half the rate of the person who managed the turnaround. Today, they pay the same tax rate.
If implemented, this tax would lead to fewer business turnarounds and lower investment returns, making us all poorer.
3. Global minimum tax. Another liberal darling and bad idea planted in President Obama's budgets, the global minimum tax is simple — tax American-based multinational companies a minimum amount on their worldwide income. Currently, American companies owe taxes on income earned elsewhere only when they bring the money back to the U.S.
The proposal sounds fair, until you realize that the companies have already paid taxes in the other countries where they earn income, and that the U.S. is one of only a few countries to tax businesses' worldwide income. As a result, the tax incentivizes businesses to move out of the U.S. to any of the more than two dozen major economies that don't impose worldwide taxes.
Tax reform won't happen unless policymakers start to separate the good ideas from the bad. A close look at these six proposals would be a good way to start that process.
Ryan Ellis is a senior adviser for tax policy with the Conservative Reform Network.