How to Rescue Tax Reform
The news last week that Senate Finance Chairman Max Baucus will become the next ambassador to China has cast new doubt on the already doubtful prospects of comprehensive tax reform. Baucus was one of two congressional leaders championing the idea, and in his absence the goal looks even less attainable. Instead of pushing any changes even further into the distance, maybe there's a better option: changing the goals for tax reform in a way that makes it easier to accomplish.
When people talk about tax reform, they generally mean two things: reducing the top corporate tax rate of 35 percent, which is high by international standards, and paying for it by removing or trimming the tax code's various loopholes -- or base-broadening, in the parlance of the tax industry. Most people agree on the first part; it's the second part that's hard. Brutal is more like it.
So why not just forget about the second part? Rather than bang heads over which sector should lose which tax break, there's another way to pay for a reduction in the statutory rate: taxing dividends and capital gains as regular income.
Start with the math. Reducing the corporate rate to 25 percent would reduce revenue by $571 billion from 2014 through 2018, according to the nonpartisan Joint Committee on Taxation. As it happens, the committee estimates that lower tax rates on dividends and long-term capital gains cost about the same amount -- $616 billion from 2013 through 2017. (I can't take credit for this idea; a friend and tax-policy expert flagged it while asking not to be identified on the grounds that he didn't want to appear to be advocating for tax policy.)
Obviously, altering the rates would change these estimates, so any proposal along those lines would require closer study to get a tailored cost estimate. The question is, would it be a good idea?
That depends on what you think the ancillary goals of tax reform ought to be. Paying for a lower rate by closing loopholes would make the system less complicated and, by extension, fairer. Firms would compete more on the quality of what they produce and less on the quality of their tax lawyers. Abandoning efforts at base-broadening would mean walking away from that goal, at least for now -- assuming that goal was ever within reach to begin with.
But simplicity isn't the policy goal worth pursuing through tax reform. Rising income inequality arguably is of greater concern to the average person than the complexity of the U.S. tax code, and it's equally problematic for the economy. That much is clear; what's unclear is how to deal with it.
Taxing investment income at the same rate as other earnings would be a good start. Almost 70 percent of the benefits of lower rates on dividends and capital gains go to people earning more than $1,000,000 a year, according to the Tax Policy Center; only 3.2 percent go to those making less than $100,000.
So raising those rates would accomplish the Democratic goal of shifting more of the country's total tax burden onto the wealthy. But using the money to cut the top corporate tax rate would also accomplish a goal that Republicans embrace: making U.S. companies more competitive. That helps the owners of those companies as much as anyone.
And, as Bloomberg View has argued, moving more of the corporate tax onto shareholders would reduce the significance of tax gimmicks, such as subsidiaries in Ireland that barely exist, that are designed to reduce U.S. earnings.
Change of this kind wouldn't be easy. The beneficiaries of low tax rates on investment income would resist it, and their defenders in Congress would cry class warfare. And the broader question plaguing tax reform -- whether any package should produce a net increase in federal tax revenue rather than just paying for a lower corporate rate -- would remain the subject of intense argument.
But those are all debates that have to happen anyway, and they make the fight over base-broadening even less appetizing, especially now that Baucus is leaving early. So instead of lowering our expectations of success for tax reform, maybe it's time to start thinking about how to define success in a way that's a little bit easier to achieve.
(Christopher Flavelle is a member of Bloomberg View's editorial board. Follow him on Twitter.)