Posts Tagged ‘tax reform’

According to an article in the New York Times, the Obama Administration is seriously examining a proposal to reduce America’s anti-competitive 35 percent corporate tax rate.

The Obama administration is preparing to inject an unpredictable new variable into its economic policy clash with Republicans: a plan to overhaul corporate taxes. Economic advisers have nearly completed the process initiated in January by the Treasury secretary, Timothy F. Geithner, at President Obama’s behest. That process, intended to make the United States more competitive internationally, has explored the willingness of business leaders to sacrifice loopholes in return for lowering the top corporate tax rate, currently 35 percent. The approach officials are now discussing would drop the top rate as low as 26 percent, largely by curbing or eliminating tax breaks for depreciation and for domestic manufacturing.

This may be a worthwhile proposal, but this is an example where it would be wise to “look before you leap.” Or, for fans of Let’s Make a Deal, let’s see what’s behind Door Number 2.

To judge Obama’s plan, it is important to have the right benchmark. An ideal corporate tax system obviously should have a low tax rate. And it also should have no double taxation (tax corporate income at the business level or tax it at the individual level, but don’t tax it at both levels).

But it’s also important to have a simple and neutral system. The right definition of corporate income for any given year is (or should be) total revenue minus total costs. What’s left is income.

This may seem to be a statement of the obvious, but it’s not the way the corporate tax code works. The system has thousands of complicated provisions, some of which provide special loopholes (such as the corrupt ethanol credit) that allow firms to understate their income, and some of which impose discriminatory penalties by forcing companies to overstate their income.

Consider the case of depreciation. The vast majority of people understandably have no idea what this term means, but it sounds like a special tax break. After all, who wants big corporations to lower their tax bills by taking advantage of something that sounds so indecipherable.

In reality, though, depreciation simply refers to the tax treatment of investment costs. Let’s say a company buys a new machine (which would increase productivity and thus boost wages) for $10 million. Under a sensible and simple tax system, that company would include that $10 million when adding up all their costs, which then would be subtracted from total revenue to determine income.

But the corporate tax code doesn’t let companies properly recognize the cost of new investments. Instead, they are only allowed to deduct (depreciate) a fraction of the cost the first year, followed by more the next year, and so on and so on depending on the specific depreciation rules for different types of investments.

To keep the example simple, let’s say there is “10-year straight line depreciation” for the new machine. That means a company can only deduct $1 million each year and they have to wait an entire decade before getting to fully deduct the cost of the new machine.

Ultimately, the firm does deduct the full $10 million, but the delay (in some cases, about 40 years) means that a company, for all intents and purposes, is being taxed on a portion of its investment expenditures. This is because they lose the use of their money, and also because even low levels of inflation mean that deductions are worth significantly less in future years than they are today.

To put it in terms that are easy to understand, imagine if the government suddenly told you that you had to wait 10 years to deduct your personal exemption!

Let’s now circle back to President Obama’s proposal. With the information we now have, there is no way of determining whether this proposal is a net plus or a net minus. A lower rate is great, of course, but perhaps not if the government doesn’t let you accurately measure your expenses and therefore forces you to overstate your income.

I’ll hope for the best and prepare for the worst.

P.S. It’s also important to understand that a “deduction” in the business tax code does not imply loophole. If you remember the correct definition of business income (total revenue minus total costs), this means a business gets to “deduct” its expenses (such as wages paid to workers) from total revenue to determine taxable income. Some deductions are loopholes, of course, which is why a  simple, fair, and honest system should be based on cash flow. Which is how business are treated under the flat tax.

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I spoke at the Tea Party Patriots convention earlier today. Great people, great crowd.

My job was to debate on the side of the flat tax over the fair tax. Several people asked for more information, and I promised to put this video on the blog. Long-time readers probably will have seen it before, but it’s always good to be reminded why we need tax reform – and also reminded why we can’t trust politicians with a new source of revenue.

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Here’s a video arguing for the abolition of the corporate income tax. The visuals are good and it touches on key issues such as competitiveness.

I do have one complaint about the video, though it is merely a sin of omission. There is not enough attention paid to the issue of double taxation. Yes, America’s corporate tax rate is very high, but that is just one of the layers of taxation imposed by the internal revenue code. Both the capital gains tax and the tax on dividends result in corporate income being taxed at least two times.

These are points I made in my very first video, which is a good companion to the other video.

There is a good argument, by the way, for keeping the corporate tax and instead getting rid of the extra layers of tax on dividends and capital gains. Either approach would get rid of double taxation, so the economic benefits would be identical. But the compliance costs of taxing income at the corporate level (requiring a relatively small number of tax returns) are much lower than the compliance costs of taxing income at the individual level (requiring the IRS to track down the tens of millions of shareholders).

Indeed, this desire for administrative simplicity is why the flat tax adopts the latter approach (this choice does not exist with a national sales tax since the government collects money when income is spent rather than when it is earned).

But that’s a secondary issue. If there’s a chance to get rid of the corporate income tax, lawmakers should jump at the opportunity.

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In an interview with the Wall Street Journal, Clint Eastwood is asked about the new governor of California and uses the opportunity to advocate a simple and fair flat tax.

“But I’ll tell you when I liked him—and I wasn’t a registered Democrat—but I liked him when he was running for president [in 1992] on the flat tax. . . . A ton of economists, both liberal and conservative, have argued for a flat tax, but nobody’s ever had the nerve to do it. . . . It would simplify things, but simplification doesn’t seem to be in the human psyche.”

It’s always good to get endorsements from the right kind of celebrities. Years ago, the nation’s most infamous shock jock, Howard Stern, praised the flat tax. I used to listen to Stern every day, so that was a win-win situation from my perspective, but I realized that he wasn’t universally admired.

Clint Eastwood isn’t nearly as controversial, so perhaps he can be the public face of tax reform. Actually, maybe he’s the actor who should have been governor of California. Unlike Schwarzenegger, he would have known how to deal with greedy special interest groups.

I’m no Dirty Harry, so I can only push for a flat tax with words.

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Republicans did a terrible job last time they were in power. The created a new entitlement program for prescription drugs. They further centralized education with the no-bureaucrat-left-behind legislation. They undid the positive reforms of the 1990s with central-planning subsidies and controls for agriculture. And they became earmark junkies as part of their votes to massively increase the burden of government spending.

Republicans say they’ve learned their lessons, and I’m sure many of the new Tea Party-oriented members genuinely want to expand freedom and prosperity for the American people, but it’s always wise to be skeptical when dealing with politicians.

If the GOPers really want to do the right thing and demonstrate their new-found commitment to liberty and sound governance, they should make – and keep – the following New Year’s resolutions. To keep it simple, realistic, and achievable, we have only six resolutions. Three resolutions deal with public policy and three resolutions are about resisting the seductive corruption that is so ubiquitous on Capitol Hill.

The three policy resolutions list things that House Republicans could adopt. That doesn’t mean they will make it through the Senate or get approved by the President. These are ideas that Republicans can pursue to show they are serious about doing what’s right for the country.

1. Limit the overall growth of government spending. America is in a fiscal mess because federal government spending has more than doubled since Bill Clinton left office. Bush was a big spender. Obama is a big spender. And Republicans and Democrats on Capitol Hill have been big spenders. Now that we’re in a deep hole, the first imperative is to stop digging. It would be nice to actually cut spending, but simply limiting the annual growth of federal spending so that it grows no faster than inflation would yield very good results. The key to fiscal responsibility is making sure the productive sector of the economy grows faster than the burden of government spending.

2. Repeal Obamacare, but understand that much more needs to happen to fix the health care system. It is a certainty that the House GOP will vote to repeal Obamacare as one of their first acts, but that will be a symbolic step since Harry Reid’s Senate obviously won’t consider such a step. Republicans, however, can use the discussion as an opportunity to educate themselves and the American people about how government intervention crippled the healthcare system even before Obamacare was enacted.

3. Push for real tax reform by lowering tax rates and curtailing tax distortions. One of the pleasant surprises of 2010 was the decision, by both Obama’s Fiscal Commission and the Domenici-Rivlin Task Force, to endorse lower tax rates and fewer tax loopholes. Both groups also wanted a higher tax burden, so the overall packages were not acceptable, but it nonetheless is remarkable that they rejected Obama’s approach of class-warfare taxation based on higher tax rates. Surely the House GOP can take the good parts of those plans and push even farther and take a big step toward a flat tax.

Most of us understandably pay attention to the big policy issues, such as the ones covered by the three previous resolutions. But if we want better policy, it’s also important to change the culture on Capitol Hill. If Republicans abide by these three resolutions, they would be comparatively immune to the routine corruption that is so common in Washington.

1. Don’t succumb to bribery by accepting campaign cash to push policies that hurt America. It’s not against the law to get contributions in exchange for earmarks and other special-interest favors, but it would be criminal behavior anyplace other than Washington. An overwhelming percentage of lawmakers presumably know that things such as ethanol subsidies are terrible public policy, but they get enacted because the agribusiness industry doles out contributions to politicians from both parties. The same is true of earmarks. If the GOP swore off this corrupt process, the result would be better policy.

2. Don’t put the interests of your committee above the interests of the nation. It is very common for lawmakers to strongly identify with the committees on which they sit. This is why Republican appropriators often side with Democrats to defend earmarks and other types of wasteful spending. Similarly, Republicans on the committee dealing with education are more likely to be bad on that issue than other members of the GOP caucus. And Republicans on the transportation committee are worse on those issues than their colleagues. Committee term limits would help, but the only permanent solution is for attitudes to change.

3. Take the Constitution seriously. Members of Congress take an oath of office to uphold the Constitution, and the GOP specifically has announced that they want all legislation to include an explanation of why it is consistent with the Constitution. That’s great news, but only if Republicans are serious. But does anyone think that the GOP is ready to bar any legislation funding the Departments of Education, Energy, Agriculture, and Housing and Urban Development? None of these bureaucracies should exist according to the Constitution. So if the GOP is going to do its job, they need to treat the Constitution as more than a political talking point

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In my fiscal policy speeches, I sometimes try to get a laugh out of audiences by including a Powerpoint slide with this image. Leading up to this slide, I talk about the Armey/Forbes flat tax and explain that it would eliminate the corrupt internal revenue code and replace it with a simple 10-line postcard. But I then warn that simplicity is not the same as low taxes and show the Obama slide.

But maybe jokes about Obama tax reform were a bit premature. According to the New York Times, the White House is giving serious consideration to a sweeping plan to streamline the tax system.

While administration officials cautioned on Thursday that no decisions have been made and that any debate in Congress could take years, Mr. Obama has directed his economic team and Treasury Department analysts to review options for closing loopholes and simplifying income taxes for corporations and individuals, though the study of the corporate tax system is farther along, officials said. The objective is to rid the code of its complex buildup of deductions, credits and exemptions, thereby broadening the base of taxes collected and allowing for lower rates — much like a bipartisan majority on Mr. Obama’s debt-reduction commission recommended last week in its final blueprint for reducing the debt through 2020. Doing so would offer not only an opportunity to begin confronting the growth in the national debt but also a way to address warnings by American business that corporate tax rates and the costs of complying with the tax code are cutting into their global competitiveness.

There’s actually much to like in the Administration’s potential plan. Lower tax rates will help the economy by improving incentives for productive behavior. And getting rid of distortions will further enhance growth since people no longer would have an incentive to make inefficient decisions just for tax purposes. And simplification could have a profound impact on cleaning up the horrible mess at the IRS. Moreover, a plan that trades lower tax rates for fewer tax distortions would be a welcome change from the poisonous soak-the-rich tax policy the White House has been pursuing.

This sounds like good news, but there’s a catch. The White House is looking at this exercise as a way to not only clean up the tax code, but also as a way of getting more money for politicians. This blog post explains why this is the wrong approach from an economic perspective, but politics will be an even bigger obstacle.

The American people want tax reform, but they don’t want more of their money going to Washington. And most Republican politicians have wisely pledged not to support legislation that increases the overall tax burden.

So the ball is in Obama’s court. If he genuinely wants to make America more prosperous and competitive, he should move forward with plans to lower tax rates and eliminate tax distortions, but he needs to tell his staff that tax reform should not a Trojan Horse for a tax increase.

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At least, that’s what a left-wing blogger thinks.

So what did I do to earn this honor? I had the gall to say that tax loopholes should be removed, but that all the revenues should be used to finance lower tax rates.

Call me crazy, but I don’t think either our economy or our fiscal situation will be improved by giving more money to the folks in Washington. I guess that means I should be sent to an asylum.

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