The conventional wisdom is that tax reform is dead.
Sen. Ron Wyden, D-Ore., who is likely to assume the chairmanship of the Senate Finance Committee, is a longtime supporter of reform. His campaign website makes clear that he’s still on board. “[L]et’s get rid of the special interest tax breaks, let everybody file their taxes on a one-page form, and make sure that a dollar earned through work is taxed the same as a dollar earned through investment,” it reads.
Advocates of comprehensive tax reform were discouraged by the surprise announcement late last year that Sen. Max Baucus, D-Mont., was giving up his chairmanship of the Finance Committee to become the U.S. ambassador to China. In fact, he was simply passing the reform torch to someone extremely capable and also committed to the cause.
Lawmakers like Wyden understand that the economy overall and businesses in particular would benefit from traditional tax reform, which would lower tax rates and end many credits and deductions.
This approach will create a fairer and more transparent system. According to a study by S&P Capital IQ, S&P 500 companies take advantage of credits and deductions at widely varying rates, meaning some companies pay virtually no taxes while others pay close to the statutory rate.
About 1.6 million companies, most of them very large, pay taxes through the corporate income tax system. Their top rate is 35 percent. Not only is this the highest rate in the world, American companies also bear the world’s highest effective tax rate on the amount they actually pay to Uncle Sam after credits and deductions. According to the Business Roundtable, U.S.-based companies pay a rate higher than those based in Germany, Japan and China —a fact that severely diminishes U.S. competitiveness.
But lawmakers shouldn’t only lower corporate rates. They need to reduce individual rates as well. The vast majority of U.S. businesses, it turns out, are not classified as corporations and pay federal taxes through the same system individuals do.
According to the Tax Foundation, about 30 million U.S. companies pay taxes using individual income tax rates. This number has increased exponentially in recent decades while the number of businesses that pay corporate rates has fallen. The top marginal individual income tax rate, at 39.6 percent, is even higher than the top corporate rate. This means some small businesses pay even higher rates than corporations. That hardly seems fair.
If lawmakers move to lower the tax rate corporations pay, they should also lower rates for the 30 million businesses that pay through the individual rate system.
Lowering rates overall would reduce the complexity of the tax code.
According to the IRS’ Taxpayer Advocate Service, American taxpayers devote 6.1 billion hours to comply with the tax code each year, an effort that costs $168 billion in accounting fees on top of the actual IRS bills. That $168 billion is equivalent to 15 percent of all federal tax receipts. These savings could be far more economically beneficial if they could be used to hire new employees, increase existing workers’ salaries and benefits or be invested in new equipment that would improve productivity and fuel jobs in the still-struggling manufacturing sector.