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Tax Cuts vs. True Reform

By Howard Gleckman Bubbling just beneath the surface of the Great $1.6 Trillion Tax-Cut Debate is a far more interesting and substantive issue: completely revamping the way government taxes both individuals and businesses. Skeptics hear the phrase "tax reform" and scoff -- it's easy to dismiss an idea that sets the hearts of economists aflutter but never gets any political traction. Still, hints are out there that suggest a fundamental restructuring of the tax code may get a stonger hearing in the next few years than ever before.

First, there's money to work with. This is important, because true tax reform will, by necessity, create losers -- those individuals and companies who have been using tax breaks and subsidies to pay little in taxes. With a projected $3.1 trillion non-Social Security surplus, an opportunity to check them into the fiscal equivalent of the Betty Ford Clinic for tax-loophole dependence.

Just as important, reform has never had more powerful friends. New Treasury Secretary Paul O'Neill is so committed to the concept that, as CEO of Alcoa, he helped bankroll the design of one important reform proposal that would essentially exempt all savings from taxation. The new chairman of the Senate Finance Committee, Republican Chuck Grassley of Iowa, is sold on the other plank of sound tax reform: dumping special-interest tax breaks and sharply cutting tax rates.

FEEDING FRENZY. And there's another powerful player in this: business. For a year now, Corporate America has been quietly whispering about broad-based reform to Bush economic advisers. At first glance, all that whispering doesn't seem to have gone anywhere. Bush's plan does nothing for business. And while it cuts individual rates, it doesn't touch the scores of special-interest tax breaks that currently clutter the code. In fact, Bush would add even more junk tax breaks for health-care costs, to send kids to private schools, even a deduction for teachers to buy pencils.

Predictably, business lobbyists are all lining up at the trough. Everyone from insurance companies to oil drillers is drooling over the possibility of getting even more tax breaks. But some execs are still looking at adding more broad-based business tax changes to the mix. The biggest of all is aimed at eventually allowing companies to expense, or write off in the first year, the cost of capital equipment.

What O'Neill and Grassley both seem to understand is that even with a huge surplus, Bush can only tinker around the edges of the basic code. For instance, if the President really wants to slash rates, he'll still have to get rid of tax breaks for health-care costs, education, employee parking expenses, and the rest as a way to pay for rate cuts without raising a political furor.

DITCH IT ALL. The same math works with the corporate income tax. Shifting to expensing would be very costly at first. And to get there, business will have to give up something. The most important and the most likely: the deduction it gets for interest expenses. But O'Neill would go even further. He would not only ditch targeted tax breaks for business, he would also abolish the entire corporate income tax.

And that brings the debate into focus. The concept is pretty simple. You could tax all income one time -- and only when it is spent. As long as the dough is invested, it remains tax-exempt. And that's how to marry corporate and individual tax reform. It would work like this: I own shares in XYZ Corp. As long as XYZ pours its profits back into its business, no taxes are paid. If XYZ pays me a dividend, it remains untaxed until I spend it.

Economists have long fantasized about such an efficient tax scheme, exempting savings while taxing consumer consumption. Reform is an important idea that will never get anywhere unless Bush embraces it. But in the campaign, he talked about reform as a second step after tax cuts. Who knows, if Bush doesn't let tax-cutting run amok, and if he listens to people like O'Neill and Grassley, he might even be able to pull it off. Gleckman is a a senior correspondent in BusinessWeek's Washington bureau. Follow his views twice a month in Washington Watch, only on BW Online

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