A GOP Tax Plan Aimed at the Middle Class, Not Rich Investors
Mike Lee, a Republican senator from Utah, has already established that he is willing to break from the pack on tax policy. Most Republican reform plans over the last decade have viewed their primary mission as minimizing the top tax rate on high earners. Lee has instead promoted changes that put a reduction in tax burdens on middle-class parents at its center.
Now he is proposing another change in GOP tax policy. Instead of seeking to cut taxes on capital gains and dividends, as Republicans have been trying to do for decades, he would raise them. But at the same time he would be bolder than his colleagues about corporate taxes. Where most Republicans want to cut corporate rates -- President Donald Trump ran on cutting them to 15 percent -- Lee wants to abolish the tax altogether.
His plan is based on work done by Eric Toder and Alan Viard, economists who work respectively for the Urban Institute and the American Enterprise Institute (where I am also a fellow). Their proposal is aimed at fixing some well-known problems of the corporate tax. The tax encourages companies to finance investments through debt rather than equity, to reinvest their earnings rather than pay dividends, and to retain foreign earnings overseas rather than invest them in the U.S.
Individuals’ income from dividends and capital gains is taxed at a lower rate than their income from labor. The main point of that differential treatment is to avoid double taxation: Much of this capital income has already been taxed at the corporate level. But if the corporate tax is eliminated, it makes sense to tax individuals’ capital income at the higher rate they pay on labor income.
Making that trade would also have significant advantages. Americans would be taxed on their capital income no matter where the companies in which they hold shares incorporated or invested. An individual is less likely to emigrate from the United States to avoid capital taxes than a company is to shift its assets to avoid the corporate tax. So taxing capital income at the individual level is less likely to discourage investment in the U.S. than taxing it at the corporate level.
Senator Lee sees this idea through the prism of the debate over trade. “We can’t shut down the global economy,” he tells me. “What we can do is bring more of the global economy here and channel more of the fruits of the global economy to American workers.”
Unlike proposals for higher tariffs or other kinds of taxes on imports, Lee says, this new approach to business taxation would “align the interests of global investors and American workers.”
As they have refined their proposal, though, Toder and Viard have included some features that Lee has not adopted. Under current law, capital gains are taxed when they are realized. Raising the capital-gains tax creates a “lock-in” problem: People will avoid selling their stocks in order to avoid paying the tax.
The economists would therefore switch to taxing capital gains as they are accrued. But share values can be volatile, and taxing capital on an accrual basis could have the opposite effect: forcing people to sell assets that have sharply appreciated to pay the tax.
So the plan would also include a “smoothing” provision. Lee would stick with taxing capital gains when they are realized, thus avoiding the need for smoothing but creating the lock-in problem.
The economists also decided to cut the corporate rate to 15 percent rather than eliminate the tax altogether. They made this change in part to keep their proposal from causing too large a loss in federal revenue, but also for other reasons: It made it possible to tax foreign investors, for example.
That adjustment, though, necessitated another. Keeping the corporate tax while raising capital taxes on individuals re-created the problem of double taxation, which they would remedy by giving shareholders a tax credit. Lee, on the other hand, would just scrap the corporate tax, telling me he prefers “the simplicity of just zeroing it out.”
But he also says that he is flexible on the details. Going for simplicity makes sense when introducing an unfamiliar idea to the political debate. “What I am trying to do is start a conversation,” he says.
It’s a potentially productive conversation. It’s just bound to get more complicated as it progresses.
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