One of the dominate topics in legislative conversations these days is fundamental tax code reform at both the national and state levels, and it is also one of the ripest areas for big legislation this year. The common chorus is that taxes are too high for individuals, families, businesses and investors. But it’s a complicated, multifaceted issue that’s been tweaked then stalled and tweaked again in “small ball” reforms for the past two decades.
Historically, analysts point to the 1986 Reagan tax reform as the most impactful action in recent history. That plan reduced the rate on ordinary income from 50 percent to 28 percent while raising long-term capital gains rates from 20 percent to 28 perent. But modifications on ordinary income is but one of the variables that has to be considered.
On the corporate side, the way the tax code treats corporations remains one of the biggest drains on domestic growth; the U.S. rate of 39 percent is the highest of any of the 34 most industrialized countries in the world. This not only prevents foreign companies from expanding operations to America, it motivates U.S. companies to relocate some activities abroad. Additionally, the U.S. is the only major nation that taxes income companies earn in foreign operations; effectively suppressing job creation and wage growth at home for American workers.
Another discussion regarding how the current tax code impacts business is the different treatment given to corporations verses small businesses that make up the vast majority of the U.S. economy. The so called “pass through firms” are made up of sole proprietors, partnerships, limited liability companies and S-corporations. These businesses are not taxed through the corporate tax system, but on their owners’ individual tax returns. Therefore, high tax rates on small businesses reduce their ability to expand operations, hire additional workers and increase wages.
Multiple layers of taxes, likewise, inhibit investors from backing promising opportunities for new business development. These C-corporations pay a rate of 35 percent, and investment return is then subject to taxes on capital gains and dividends. Combined, it all can have a dampening influence on entrepreneurship, which is a dramatically growing focus of the millennial generation that is projected to be 75% of the workforce by 2030.
Adding to the incredibly complicated current corporate and individual tax codes are the dizzying array of deductions, exemptions, credits and carve-outs generally initiated and retained by special interest pressure. This malaise of conflicting and overlapping exceptions make the current rules not only incomprehensible but patently unfair across the board. One of the key objectives of tax reform needs to be to create a code that is simple, transparent and more fair.
But these simplifications mean making unpopular choices. Lower rates, broadening the base and simplifying the tax code dictates the triangulation of the House, Senate and President on the national level and the Kentucky House, Senate and Governor on the state level.
Alternatives put forward to replace some elements of the current tax regulations include consumption taxes that tax purchases and service taxes that tax business operations. Each of these are alternatives that can replace the exemptions/deductions scheme in the current system. However, while they can accomplish simplicity and ease of administration as proponents say, opponents line up to protect special interests that benefit from those tax breaks. Additionally, some argue the consumption and service tax idea negatively and disproportionally affects lower and middle income groups.
Meaningful reform should have a series of goals:
• To lower rates in order to strengthen the economy by improving incentives to work, save and invest.
• To establish the correct, neutral tax base, one which doesn’t pick winners and losers.
• To establish a simple, transparent code that demonstrates how taxes fund the government.
Ideally, the end-game objective is to accomplish meaningful reform without blowing up deficits. Achieving successful tax reform begins with a genuine commitment to a common bipartisan goal reached through compromise driven by pressure from the citizenry. Doing comprehensive tax reform is hard; not doing comprehensive tax reform is dangerous. ■
Dick Kelly is publisher of The Lane Report. He can be reached at [email protected]