How to Make Tax Reform Bipartisan
The implosion of the Republican health-care bill shows the limits of what one party alone can do in Washington. Tax reform will be even trickier, since it touches a larger fraction of the economy and threatens more powerful vested interests. The only hope for seriously revamping America’s inefficient business-tax system to unlock stronger economic growth is a bipartisan approach, but it will require a course correction by President Trump. Here are five important steps to building a sensible tax reform:
• Commit to revenue neutrality and distributional neutrality, as in the 1986 tax reform. In other words, a bipartisan plan would focus on making the tax system more efficient, without cutting the revenue raised or shifting the burden in any direction. This would not require a change in rhetoric. House Speaker Paul Ryan has already said tax reform should be revenue-neutral, and Treasury Secretary Steven Mnuchin has said that there will be “no absolute tax cut for the upper class.”
Any specific legislation should be judged against these benchmarks by the nonpartisan analysts at the Joint Committee on Taxation, a group that incidentally now uses dynamic scoring in assessing major tax changes. But the frameworks put out last year by the Trump campaign and House Republicans do not pass the test. They would add trillions of dollars to the deficit while providing, respectively, 50.8% and 99.6% of their benefits to the top 1%, according to the Tax Policy Center.
• Focus on business taxes only. This is where the largest economic gains from tax reform can be found. In part that’s because companies can and do move across borders in search of lower taxes, while individuals are much less likely to do so.
For a reformed system to work, all large companies should have to file under the corporate tax code, as President George W. Bush’s tax-reform commission proposed. Small businesses should have their rates left alone but could be helped in other ways—for instance, with more-generous tax breaks for research or employer benefits.
• For overseas business income, adopt something like a “minimum tax.” The current system, which taxes American companies on their repatriated earnings at the regular rate of 35%, is badly broken. It raises little or no revenue while imposing substantial distortions, such as giving firms an incentive to stash money overseas permanently.
A minimum tax instead would apply to all overseas earnings at some intermediate rate—President Obama proposed 19% and Republican Sen. Rob Portman supported a lower rate. Earnings could then be repatriated tax-free. A minimum tax would not apply to investments in countries like Germany or the U.K., which already tax American companies doing business there at over 19%. But on investments in low-tax countries like Ireland, which has a corporate rate of 12.5%, American firms would pay the difference. Profits reported in tax havens like the Cayman Islands could end up facing nearly the full 19%.
This is a less elegant solution to taxing international income than the House Republican plan of shifting to a territorial system with a border adjustment. But the GOP proposal comes with serious side effects: large movements in the currency, shifts in asset prices, and the potential to start a trade war. A minimum tax would avoid all of those.
• For domestic business income, adopt something along the lines of the House Republican proposal. Shift from taxing profits to taxing cash flow. This would allow businesses to expense their investments fully while disallowing interest deductions—effectively like a consumption tax. At the same time, eliminate as many loopholes as possible and lower the tax rate as far as possible. These reforms would make the tax system neutral toward investing in different types of assets, as well as neutral between financing with debt or with equity.
How low could rates drop? Closing loopholes and moving to an international minimum tax would provide some revenue. If the goal is revenue neutrality, then getting the rate down to 28% might be possible. But the 15% or 20% rate proposed by the Trump campaign and House Republicans, respectively, would be impossible without massively raising the deficit.
• Incorporate into the bill a real plan for public infrastructure spending. The goal should be to expand investment meaningfully in America’s roads, bridges, railways and airports. It could be funded with a mandatory one-time tax—say, of 15%—on unrepatriated foreign earnings as part of the transition to the new international tax system. Both tax reform and infrastructure would be good for growth—and pairing them has been a staple of Democratic and Republican proposals alike in recent years.
Following these five steps is the way to enact genuine, durable tax reform. If Republicans work alone, they might be able to pass a temporary tax cut through the reconciliation process, which requires only 51 votes in the Senate. But the rules of reconciliation mean that the tax cut would sunset after a decade. That would only add a new layer of uncertainty on top of America’s inefficient tax system, while swelling the budget deficit.
Real tax reform would create winners and losers, making it almost impossible to pass with only one party. Republican majorities are relatively slim, and vested interests trying to sink the legislation would need to pick off only three GOP senators or 22 representatives. An easier path would be to write a bipartisan bill and aim for the support of 30 Democrats in the Senate and 100 in the House. That could be doable, but only if President Trump is open to changing his approach.
Mr. Furman, a senior fellow at the Peterson Institute for International Economics, was chairman of the White House Council of Economic Advisers, 2013-17.