America Once Led the World on Tax Reform

‘We’re going to do what we have to do to remain competitive,’ a Canadian official said in 1986.

 
 

 
PHOTO: ISTOCK

Three decades ago, Ronald Reagan worked with Congress to give the U.S. a modern, competitive and pro-investment tax system that set the stage for more than a decade of economic growth. Tax shelters disappeared at the stroke of the president’s pen. Rates were cut, deductions were trimmed and a slew of special breaks were abolished. As Australia’s Prime Minister Malcolm Fraser put it at the time: “A young man just starting out here might not move to Hong Kong in search of lower tax rates, but he might well go to the U.S.”

Two years earlier, in 1984, British Prime Minister Margaret Thatcher significantly cut corporate tax rates, and the world only yawned. When the U.S. acted in 1986, it launched something akin to a gold rush. “European countries are affected by Washington’s tax competition more than by competition among their continental neighbors,” UniCreditnoted in a February 2017 report, recalling the Reagan tax reform. In the three decades since, other nations have followed the U.S. lead, competing to lower their corporate rates while broadening their tax bases.

But Washington has forgotten the lesson it taught the rest of the world. As the U.K., Ireland, Canada, the Netherlands, Hungary and other democracies made their tax systems friendlier to investment, the U.S. went the opposite direction. As they flattened tax rates and eliminated deductions, America tossed aside the 1986 reform and succumbed to public-policy meddling. 

Repeated political machinations created a bewildering tax system—a jumble of brackets, rising rates and special deductions, with exemptions and exclusions for everything from the production of sugar cane to the destruction of obsolete equipment. More than 5,900changes have been made to the tax code since 2001, according to the Internal Revenue Service’s taxpayer advocate.

In contrast, the British cut their corporate tax rate from 28% in 2010 to 20% today. As if on cue, government economists predicted that tax receipts would drop. Instead, corporate tax revenue has increased 28% since 2012, according to a March report by the Centre for Policy Studies.

Canada’s federal corporate tax rate is only 15%. It applies exclusively to revenue earned inside the country, instead of around the world, as the U.S. tax does. This is a major reason why Burger King is now a Canadian company.

Americans started this tax revolution 30 years ago, and it’s time they got back in the competition. Taxpayers in the U.S. deserve a much less complicated personal and corporate code, one that does not favor the well-connected and that unshackles the economy to grow again.

Governments levy taxes to raise revenue, but politicians also use the tax code for social engineering—to redistribute income, encourage saving, and reward or penalize certain behavior. The temptation to favor certain constituents and choices seems almost irresistible to America’s elected representatives.

For example, the corporate code allows businesses to deduct interest expenses, favoring debt financing over equity. But why should the government, not known for its skill in picking winners and losers, be trusted to create such incentives? Better to let the markets decide.

Moreover, all this complexity imposes huge societal costs. Last year individuals and businesses spent $409 billion and nearly nine billion hours on tax compliance, according to the Tax Foundation.

A tax code littered with exceptions for politically favored interests also breeds a well-justified cynicism—an insidious cost that’s difficult to quantify. A November 2016 Reuters poll found that 72% of Americans believe the “economy is rigged to advantage the rich and powerful.” It’s hard to argue that they’re wrong.

In 1986, after Reagan’s reforms went through, Canada’s assistant deputy minister of finance, Peter Daniel, called his country to action. “There’s no question we’re concerned about companies and individuals moving to the U.S.,” he said. “We’re going to do what we have to do to remain competitive.’’

Lower tax rates do not guarantee economic growth, but they help. Simplicity would get the U.S. closer to efficiency and fairness. It would also keep America ahead of the international competition, allowing the U.S. to once again serve as a model for the world to emulate.

Ms. Ketterer is co-founder and CEO of Los Angeles-based Causeway Capital Management.

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