Taxes

Republicans Need Tax Principles. Like These.

Reforms should be guided by big-picture goals. For example, the system should treat comparable taxpayers similarly.

Better goals, please.

Photographer: Andrew Harrer/Bloomberg

The debate over the tax reform framework released by Republican congressional leaders and the administration of President Donald Trump has rightly focused on the implications of its details — some known, some not — for the middle class, the rich, and the deficit.

If these details are the trees, then what is the forest? What big-picture goals should the GOP leaders be trying to accomplish with tax reform? What principles should they be trying to advance?

Here’s one: The tax system should treat similarly situated people in roughly the same manner. Under current law, for example, two otherwise identical households living in different states — same income, same ages, same number of children — face a different federal tax bill because the tax code allows state and local tax payments to be deducted from federal taxable income.

The tax framework rightly does away with this tax deduction. The government shouldn’t transfer money from taxpayers in low-tax states to those in high-tax states, and citizens who choose to live in high-tax states should be understood to be paying for the additional services those state and local governments provide. In addition, the GOP leaders’ framework would repeal Section 199 of the business code, which provides preferential tax treatment for (primarily) manufacturing production and thus violates the principle that profits are profits, no matter the industry in which they are generated.

But the framework doesn’t go far enough. For example, it explicitly leaves in place the tax deduction for mortgage-interest payments, defying the principle that similarly situated people should pay similar taxes by giving a break to people who own rather than rent their homes.

The primary purpose of the tax system is to provide the government with revenue. That revenue should be raised in the least distortive way possible, meaning the tax system should affect the behavior of businesses and households as little as possible.

Under a realistic tax system there will always be distortions. But the current U.S. tax code affects behavior too much. By not taxing employer-provided health insurance payments, for example, the tax code encourages firms to compensate their workers in the form of health insurance, which also increases the price of insurance. By allowing deductions for mortgage-interest payments, the tax code encourages people to buy bigger and more expensive houses. There are dozens upon dozens more examples.

There would be fewer examples under the Republicans' plan. The nonpartisan Committee for a Responsible Federal Budget estimates that their tax framework raises $1.6 trillion over 10 years from repealing itemized deductions.

That’s a good start. But the framework doesn’t touch the mortgage-interest deduction, the exclusion for employer-provided insurance or other troublesome items.

Going after these deductions and exclusions more aggressively would reduce distortions, which would result in some medium-term economic growth. It would also make the tax code less regressive, as these deductions and exclusions — which are properly thought of as government spending — accrue overwhelmingly to the benefit of high-income households.

The corporate tax system is also a mess. It is well known that the U.S. has the highest statutory corporate tax rate among advanced economies. It is less well known, but more important, that the effective marginal corporate rate — the tax rate that applies to the next unit of business investment — is the fourth highest among the nations of the Group of 20. And the average corporate rate is the third highest.

For the U.S. to be so globally uncompetitive is absurd. The high U.S. corporate rate discourages business investment at home, which reduces productivity and wages, and suppresses economic growth. It encourages U.S. companies to earn and book profits abroad.

An important goal of tax reform ought to be to encourage long-run economic growth, and Republican leaders are right to focus on encouraging business investment by lowering the corporate rate.

But the goal of long-run growth highlights the massive flaw in the GOP leaders’ plan. Over the next 10 years, the plan, as currently construed, will add over $2 trillion to the national debt. This will crowd out private investment, increase interest rates and reduce long-term growth, undoing the good done by a lower corporate rate. Another principle: Tax reform should be fiscally responsible, and this framework ain’t that.

I’ve argued for curbing tax deductions and exclusions for a few reasons, and we’ve arrived at another: Doing so can provide the revenue necessary to lower the corporate rate without increasing the national debt.

The framework adjusts the current tax system. But new systems should be considered to enact the principles of equity across similarly situated people and firms, minimizing distortions while raising revenue, progressivity, fostering long-run growth and fiscal responsibility. For example, why do we tax income at all? It would be better to tax consumption.

Maybe so, but today’s politics can’t accommodate change that radical. Better to move the current code in the right direction. The framework is a start. But for these reasons — and several others — it isn’t where it needs to be.

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

    To contact the author of this story:
    Michael R. Strain at mstrain4@bloomberg.net

    To contact the editor responsible for this story:
    Jonathan Landman at jlandman4@bloomberg.net

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