Tax Reform and Where We Should Go


President Trump and the Republican Congress have promised to do tax reform and according to Trump it will be a huge tax cut for the middle class. Another goal of any tax reform bill should be to reduce the size and complexity of the tax code and make it easier for the American public to file their tax returns. I have some thoughts on how I would approach tax reform, both as an American and as a Republican.

The very first thing I would look to do is to reduce the corporate rate.   Right now it sits at 35% and it is among the highest in the western world. We have this ongoing debate about companies doing inversions and leaving the United States. What this means is they are changing their corporate status from being a U.S. based company to one in a foreign country. They are doing this simply because they get a lower rate in the country where they move. They don’t really move that many jobs. If they have manufacturing in the United States is normally stays in the United States. It simply becomes corporate headquarter jobs that make the move. Below is a table of some other nations and their corporate tax rates.

Nation

Tax Rate
United Kingdom

19%

Ireland

12.5%

Hong Kong

16.5%

Denmark

22%

Columbia

25%

China

25%

Germany

29%

Sweden

22%

Switzerland

18%

Even under the Obama Administration they recognized that the U.S. corporate rate was too high and made the U.S. and easy target for other countries to entice companies to make the move.   They recommended reducing the rate in the U.S. to 22%. The Trump administration has said they will reduce it to 15%. I doubt they can get Congress to make it that low so a number around 22% would be a good compromise. Those on the hard left will oppose any change and some would even argue that we should tax corporations even higher. They have not idea how commerce works and view companies as the evil opposition of their goals. The extreme left would want a government-controlled economy that promised everyone a guaranteed income whether they work or not.

The other corporate rate issue that has been proposed is one that I also agree with. There would be a one time 10% tax on monies held overseas that is repatriated to the United States.   According to some studies U.S. companies have a much as $2.5 Trillion dollars overseas that they have not brought back to the U.S. due to the higher tax rate. Assuming that we could entice 50% of this to come back it would produce $500B in new revenue. And at the lower corporate rate we would see more money coming back each year that would increase revenue.

Next we have to look at individual rates. In our last major tax reform bill in 1986 Ronald Reagan and Tip O’Neil negotiated a compromise that removed a lot of deductions from people in exchange for two individual rates of 15% and 28%.   Those were the only two brackets. But under George H.W. Bush and the famous “read my lips” quote we suddenly had a 31% bracket. That was soon followed by a 33%, 35% and 39% bracket. Of course none of the deductions we gave up came back. It simply increased taxes on those people earning higher incomes in order to satiate the constant need for government to have more money for its spending programs.

The Trump administration has proposed to make the top rate in the U.S. 33% and to simplify the code. I have no problem with doing that but I would recommend some changes that will bring out the special interest guns.

There are three major deductions that people take in filing their tax returns. They are charitable deductions, state and local taxes and mortgage interest deductions. I would eliminate two of them and retain only the charitable deduction. The reasons are simple and they are both economic and political.

We are not going to be able to eliminate the charitable deduction. The pressure would be immense and it would come from both sides of the political spectrum. On the left the universities would be out in force to oppose this and on the right the churches would express their opposition. I am not sure it is a good thing to eliminate this deduction because it would remove a major incentive for people to donate to charitable causes and many of these organizations do some wonderful things in our society.

The other two would be on my chopping block. I know the homebuilders and real estate industry would become apoplectic at any suggesting in removing the mortgage interest deduction. It was inserted in the code to stimulate home building and home ownership. But the fact remains that only those people itemizing their deductions claim this on their tax returns.   According to the latest data we have from 2013 only 31% of the people in this country itemize. The rest use the standard deduction.

With the state and local tax deduction the same arguments apply. The logic behind this deduction has always been that you should not be taxed twice on the same income and so you are allowed to deduct the taxes you paid to other jurisdictions. But again, only 31% of the people are taking advantage of this deduction since you have to itemize to claim it.

So lets take a look at what these deductions actually cost the government in revenue. By eliminating the mortgage interest deduction you would increase revenue by about $405B and the state and local tax deduction would produce another $316B in revenue.   If you wanted to get after the charitable deduction, which I don’t recommend, it would produce another $250B and all told those three amount to about $1 Trillion per year in revenue.

So here is what I would do. Eliminate the two I have mentioned and create about $700B in revenue. Give a tax holiday to the money sitting overseas and create and additional $500B in revenue. Then expand the Standard Deduction (Trump has already recommended this) so that fewer people will need to itemize and use some of the increase in revenue to expand the Earned Income Tax Credit (EITC) to help the working poor. We currently spend about $350B on EITC and I would increase that to near $500B.   Increasing the Standard Deduction gives the middle class a tax reduction since they are the bulk of the people using this method.

So whom will these changes affect?   First, the bulk of the people using the itemization on their taxes are in the higher income brackets so this will be a tax increase on the wealthy. Most of the people claiming the mortgage interest deduction live in high housing cost, urban areas. I am talking about New York, Connecticut, California, Chicago and some other areas. The states with the highest state and local taxes are California and New York. Politically these are strong Democrat states so as a Republican I have no reason to protect these deductions. By increasing the Standard Deduction more people in what are now Republican states will no longer itemize. Their tax forms will get much simpler and easier to fill out.

By increasing the use of EITC we put money into the pockets of the working poor. It gives them more money to spend and that helps the economy.

Then I would take some of those additional revenues and use them to jump-start the President’s promise for investment in infrastructure. This would mean more jobs in the construction segment of the economy and the blue collar workers that Trump so strongly campaigned for would benefit.

These are just some recommendations that I have and as a Republican I see how they can help the party strengthen itself with two key groups where they need help: The working poor and blue collar workers.

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