The tax code is a mess. It’s has a labyrinth of loopholes, is inefficient, and inequitable. It’s been almost 30 years since the last major revision and it’s time for an update.
We should do this not just for the sake of efficiency or fairness, but with the goals of promoting economic growth and creating jobs. To do this we also need to reform the tax code in a progressive, pro-growth manner. In addition to keeping tax rates low, we must keep the tax system as simple as possible. By reducing the tax code’s complexity, economic decision-making becomes more market-driven than tax-driven, and improves efficiency in administration and compliance.
The Tax Reform Act of 1986 is recognized as the model for tax reform, and it should be. It was a substantial and truly bi-partisan achievement between President Reagan and a Democratic Congress. It lowered rates, broadened the base, eliminated or downsized hundreds of tax credits and deductions, and simplified the code. Individual rates were cut from a high of 50% to 28%, and corporate rates from 46% to 34%. It also curtailed the number of tax brackets from 15 to two, was revenue neutral (did not raise or lower total tax revenues), and didn’t meaningfully change the tax burden distribution.
Unfortunately, the 1986 bill has been slowly undone. Sadly, this has happened because politicians can’t help themselves when it comes to creating tax breaks for lobbyists and supporters offering large campaign contributions. Over time, it has resulted in the tax code becoming a tangle of complicated loopholes that favors special interest groups at the expense of all other tax payers.
Consequently, few Americans are happy with the current tax code and even fewer want to pay more taxes. Because of frequent stories about wasteful spending, many voters are in no mood to pony up more of their hard-earned income for what they see as an inefficient federal government.
Even more disconcerting is growing class discontent. Many of the “99%” are frustrated by income inequality, and the middle-class feels squeezed as their incomes have stagnated. The top 20% aren’t happy either because they feel over-taxed – according to the non-partisan Congressional Budget Office, in 2011 the “1%” paid 24% of all federal taxes (income, payroll and excise) and the wealthiest 20% (including the 1%) paid 69% of all taxes.
Put all of these factors together and the situation is begging for some practical solutions. Nonetheless, Congress won’t do anything because the two parties can’t agree how to proceed. Democrats want tax reform to raise more revenue, and Republicans want it to be revenue neutral.
Since the national debt is humongous and still growing, I believe we will ultimately have to figure out some ways to bring in more revenues, but I also believe that tax reform is so important that we should make deficit reduction a separate issue. Getting meaningful tax reform passed will be difficult enough, trying to pass it along with tax increases would be impossible; separating the two makes tax reform more likely to happen.
The aim of any new tax bill should be simplification. A revenue-neutral simplification of the tax code will initially bring in the same amount of taxes, and help accomplish the goals of promoting economic growth and creating jobs. Better economic growth will also generate needed additional revenues.
Like the 1986 law, a new bill should have fewer tax brackets and lower rates for everyone. But to accomplish that it will also need to include phasing out most tax breaks (deductions and credits), which should be done over a three to five year period to allow people to plan and adjust accordingly. It’s estimated that all tax breaks amount to about $1.2 trillion a year. Getting rid of most loopholes in the tax code, which tend to favor the wealthy, creates a fairer system and allows much lower tax rates – some sources say as much as 40% lower.
Lower corporate rates should also help slow tax inversion deals – a tactic used by U.S. companies to merge with a foreign company and move their headquarters overseas to avoid or reduce taxes. The Treasury Department clamped down on these mergers last year and that ended some of the pending inversions. But several U.S. companies are still pursuing inversion deals, because despite tougher Treasury rules the tax benefits remain substantial.
There is no shortage of ideas for reforming the tax code, but most are promoting more sweeping changes that have no chance of passing in today’s political climate. I believe a bill with broader appeal and beneficial to the majority of Americans has the best chance of passing. If a revised tax code fails to generate enough revenues to begin reducing our enormous national debt (as a percentage of GDP) we can go back to the drawing board then. In the mean time, a simpler tax code with fewer loopholes and lower rates would be good for the U.S.
I welcome your feedback on these topics. Feel free to leave your thoughts in the “comments“ section below. If you’d like to keep your thoughts private, please reply with an email instead.
Links to related blogs:
Building a Strong Economy: http://www.commonsensecentrist.com/building-a-strong-economy/
Budget concerns: http://www.commonsensecentrist.com/the-federal-budget-were-getting-boxed-in/
Economic growth: http://www.commonsensecentrist.com/growing-the-economy-the-road-ahead/
Fiscal policy: http://www.commonsensecentrist.com/leadership-not-misleadership/
Deficit reduction: http://www.commonsensecentrist.com/passing-the-buck-really-big-bucks-2/