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The Overbearing Rule Book Is What Blocks True Tax Reform

April 16, 2012 7 minute Read by David Malpass

As the U.S. seeks faster growth, several reforms are imperative. We need sound money to attract capital, immediate federal spending restraint from the President, his cabinet, and OMB, and a replacement for the debt limit so that it controls spending and debt rather than facilitating them. Like Europe, the U.S. government needs to switch from austerity imposed on the private sector to austerity on the government sector as a critical step to faster growth. In addition, we desperately need sweeping tax reform in order to encourage more investment and hiring. For now, however, the U.S. is losing the global battle for tax competitiveness even though there’s bipartisan agreement that it’s urgent. On the corporate side, the U.S. has the highest marginal tax rate in the developed world. A lower rate on a broader base would significantly increase our attractiveness to global investment. On the personal income-tax side, high rates, extreme complexity, and staggering compliance costs hold down U.S. growth while supporting Washington’s tax industry — at the expense of the private-sector economy. Tax reform faces many obstacles including political stalemate, entrenched economic interests, and disagreements over optimal tax policy. One of the biggest obstacles, however, is procedural — the legislative process needed to push a tax bill through Congress and to the President for signature. The normal approach to tax reform is for the President, working through the Treasury Department, to develop and propose a basic framework for tax reform. This was the approach used successfully in passing the 1986 Tax Act (on which I worked for Treasury Secretary James Baker) and the 2003 tax rate cut. Both of these reforms stimulated growth and jobs, and led to financial market gains. Tax reform in 2013 is even more important for growth but faces larger procedural obstacles than the earlier reforms. First, an increasing portion of the tax code is temporary — existing tax rates are often scheduled to increase after one or two years in order to artificially hold down the 10-year deficit. To keep the tax rate from rising automatically, Congress and the President then have to agree every one or two years on a complicated, hard-to-pass “patch” or “fix” to hold the tax code together for another year. Over the years, the theoretical cost of the fix has escalated into the hundreds of billions of dollars, including the alternative minimum tax, the “doc” fix to pay for normal Medicare costs, the tax credit for research, the capital-gains and dividend tax rates, and the 2003 Bush income tax rates, many of which have bipartisan support. This reliance on short-term rolling tax rates blocks constructive tax reform because, under Washington’s current rule book, real reform would have to acknowledge the full 10-year cost of a given set of policies rather than hiding it. A pro-growth, pro-jobs starting point for tax reform would be to make permanent many of the current annual tax fixes in order to reduce the uncertainty in the tax code and create a more honest baseline for tax reform. Since these provisions are extended automatically anyway, it would greatly enhance the prospects of tax reform for these annual tax cuts to be set aside and fixed in a one-time process that would stabilize the tax code. The surprise step toward tax reform would show global investors that the U.S. is serious about making its tax code more competitive. Even though the artificial deficit and debt estimates in the current baseline would increase as a result of the change, moving toward CBO’s alternative baseline, the net effect would make the U.S. more attractive for investment. If the temporary provisions in the code can’t be made permanent prior to tax reform, tax reform will have to get procedural protection, called reconciliation, in the congressional budget. This would allow the budget committees to guide the scoring baseline in anticipation of tax reform so that the baseline correctly recognizes that many of the temporary tax provisions are extended annually and are in fact permanent features of the tax code. A second procedural obstacle to tax reform is that it is assumed at the outset to have no impact on economic growth. Yet that’s one of the main purposes of tax reform. If reform lowers individual and corporate rates, broadens the tax base, and simplifies the code, it would clearly add to economic growth and employment and raise asset prices and tax receipts. Washington’s rule book ignores this, blocking tax reform. To fix this procedural problem, the growth benefits of tax reform should be taken into account in Congressional consideration of tax-reform legislation. One approach would be a one-time negotiated dynamic scoring of tax reform to recognize that the purpose of updating the tax code is to add to economic growth. For example, both parties might agree at the outset that a tax-reform agreement, if approved by Congress, might add 1% to average growth over 10 years. That growth dividend would become part of the tax-reform scoring process, increasing the legislative odds of getting a bill passed. It doesn’t pre-dispose the contents of tax reform, but it brings the scoring system closer to reality and addresses the scoring obstacle that has been blocking recent attempts at tax reform. With these two procedural fixes — making temporary tax provisions permanent or adding them to the baseline, and allowing a one-time scoring acknowledgement that a successful tax reform would increase growth and asset prices — a massively pro-growth tax reform process could be carried out through the budget reconciliation process. This would provide a key platform for fast economic growth. This article originally appeared on Forbes.com on April 8, 2102.


Author

David Malpass

2012 Economic Growth Fellow

David Malpass is president of Encima Global, and chairman of GrowPac. He writes a regular Current Events column in Forbes magazine, and his opinion pieces appear regularly in the Wall Street Journal. He sits on the boards of the Economic Club of New York and the National Committee on U.S.-China Relations. Formerly, Mr. Malpass was chief economist of Bear Stearns. Between February 1984 and January 1993, he held economic appointments during the Reagan and Bush Administrations. He was Deputy Assistant Treasury Secretary for Developing Nations, a Deputy Assistant Secretary of State, Republican Staff Director of Congress’s Joint Economic Committee, and Senior Analyst for Taxes and Trade at the Senate Budget Committee.

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