Principles for Pro-Growth Tax Reform
With control of Congress and the White House this year, Republicans are driving the tax reform conversation. But there’s no reason Democrats shouldn’t also be contributing to the effort by promoting their own vision of tax reform.
That’s because the need for reform isn’t about Democratic or Republican interests. It’s about an arcane system that’s holding back growth and jobs. Our tax code is a relic of a time in our country when taxpayers earned virtually all of their income through wages, businesses filed taxes as corporations, and competition was focused locally, regionally, and domestically.1 We live in a very different economy now, and our tax code is showing major signs of strain. It fails to bring in sufficient revenue, it is too complex to navigate without professionals, and it distorts decision making with ill-targeted incentives. Most importantly, the code fails the middle class in a time of dramatic economic change.
Staying true to these five fundamental objectives, policymakers will be assured that reform is adapted to today’s economy and will help grow the middle class:
1. Invest in Growth
Tax reform can create the conditions for businesses to invest in innovation, direct capital to sectors with the greatest potential for expansion, and build the foundations of new growth. Because investing in growth means spending through the tax code, it will also require prudent fiscal management to ensure deficits are not undercutting our efforts to build lasting progress.
- A lower corporate tax rate with fewer special interest loopholes will reduce distortions and even the playing field for all firms, while leaving overall revenue unchanged.
- The research credit is an important part of encouraging innovation and supports industries that are experimenting with new technologies that will drive public returns and positive spillover effects. Reform should ensure that the credit is available to more small startup ventures.
- Modernizing the way we tax multinationals with reforms similar to those of other developed countries is necessary to restore American competitiveness. As a transition system, returning or “repatriating” the nearly $3 trillion of corporate foreign earnings that are trapped outside our borders should be a priority. The tax revenue generated from repatriated profits can be directed towards infrastructure modernization and other national priorities that help U.S. companies better compete.
2. Maintain or increase revenue
Over the next five years, the federal deficit is expected to rise from $559 billion to $959 billion.2 And that’s assuming we leave the tax code as is. Further increasing future deficits would undermine growth by forcing future spending cuts to vital public investments. Some policymakers propose merely making reform deficit neutral, by paying for tax cuts with spending cuts. Some further restrictions on future spending may be necessary to control deficits, but lowering revenue further would place far too great a burden on spending cuts. Therefore, lower rates should be paid for within the tax code, not with spending reductions.
3. Maintain or increase progressivity
Given the current state of the economy, there’s simply no good reason to transfer wealth from the poor or middle class to the wealthy. Incomes and wealth have risen at the top, but wages have grown too slowly for the working and middle class. In the wake of the Great Recession, families are still struggling to build enough wealth to pay for middle-class tickets like education and retirement. Neither the poor, the working class, nor the middle class should have their share of taxes increase. And the wealthy should not have their share of federal taxes decrease. Trickle-down tax cuts have not worked in the past, and they will not work in the future.
4. Simplify the code
“Simplification” can have different meanings in the context of tax changes. Simplification does not mean collapsing the number of brackets. What makes the code complicated are not brackets, but the varying definitions of income and all the adjustments to income that permeate the code. Further, simplification should not be a justification to make the tax code less progressive as envisioned by Speaker Paul Ryan and House Republicans. True tax simplification results in a tax code with fewer tax expenditures and special rules, easier filing and lower compliance costs for all taxpayers, and fewer distortions from tax planning and uneven tax treatment. Specifically:
- Lower compliance costs for individuals. Increasing the number of simplified tax filings would ease the compliance burden for families that have to itemize and incur additional costs to ensure compliance with tax laws.
- Streamline business filings. Our current corporate tax system is such that, in order to compete globally, U.S. companies are incentivized to engage in a complicated array of expensive tax planning strategies. The consequences include cash locked offshore and a strong pull for companies to relocate abroad. A simpler corporate code with a lower rate could end the lockout effect. And because people do not shift income across borders as fluidly as corporations do, partially moving the tax on business profits to the shareholder level would help significantly.
5. Put work on par with wealth
The tax code favors the income of the wealthy more than it should, not because they earn more, but because they are more likely to earn income in the form of capital gains and dividends, which are taxed at a preferred rate. The incomes of lower- and middle-income taxpayers predominantly come from wages which, when FICA is included, generally incur a higher rate than capital gains and dividends. This differential invites manipulation of how income is reported to the IRS and how business owners choose to pay themselves and their workers.
- Income is income, no matter who makes it, or how it’s earned. So tax reform should, as much as possible, narrow the differences between the ways different income types are treated.
- There should also be an effort to expand the payoff of work. The Earned Income Tax Credit is one example of a tax parameter that has proven to be successful in raising the take-home pay of certain low-wage workers. Expanding provisions that reward work, for more people, would be an efficient use of tax incentives.
- Many in the tax reform debate argue for immediate expensing of businesses’ physical capital investments. But in the current code, there is too little that goes to helping another key ingredient for businesses—their workers. Therefore, new incentives should focus on investments in human capital. Human capital investments will be critical to developing a more skilled and productive workforce able to complement rapidly emerging technologies.
For more detailed discussion see the Ready For the New Economy report (2015): http://www.thirdway.org/report/ready-for-the-new-economy.
United States, Congressional Budget Office, "The Budget and Economic Outlook: 2017 to 2027,” Report, January, 2017. Accessed July 31, 2017. Available at: https://www.cbo.gov/sites/default/files/115th-congress-2017-2018/reports/52370-outlookonecolumn.pdf.