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Sisyphus and Tax Reform

Article by Ike Brannon March 28, 2014 //   5 minute read

House Ways and Means Committee Chair Dave Camp released his plan for a comprehensive tax reform earlier this month to a noticeable lack of applause. Despite the fact that the tax policy cognoscenti have been clamoring for such an effort since the 1990s, few people seem all that happy with what Mr. Camp proposed.

Some of the complaints are to be expected, as reform cannot happen without the goring of many special interest oxen. To name just a few, the realtors and home builders were dismayed by the reduction in the mortgage interest deduction; The step away from a territorial tax system angered the multinationals; The big-bank tax angered big banks, naturally; and the insurers declared their opposition to provisions that made it costlier for people to save for retirement using their policies.

There were also people who had philosophical objections to the reform: For instance, The Tax Foundation--long the intellectual  home for the primacy of capital investment and economic growth--declared Camps efforts to be worse than doing nothing because of its lengthening of depreciation schedules.

Of course, tax reform is not going to happen this year or next--or ever, the oddsmakers would suggest. And if it were to happen, there’s a strong likelihood that any changes would be merely ephemeral--the 1986 reforms came almost completely undone a mere decade after its passage, and it doesn’t take a tax lawyer to come up with a litany of perverse tax incentives littering the code today, a scant 28 years after we “fixed” the code. If you’re curious, Google “black liquor” and prepare to become even more cynical.

It begs the obvious question: Why on earth do we even bother going through the machinations of tax reform? Wouldn’t we be better off playing small ball and doing minor reforms when the opportunity arises and forget the idea of major reform?

It’s worth pushing the boulder up the hill, I would suggest, because major tax reform did achieve something lasting and beneficial for the economy--namely, permanently lower rates on businesses and individuals.

Of course, the individual rate has scarcely stayed in one place: after it dropped to 28% following the implementation of the 1986 reforms, each subsequent president managed to change it at least once. However, all of those rates have been more than ten percentage points below the pre-1986 top marginal rate of 50%.

A permanent ten percentage point reduction is worth something, I would submit--especially in this range. As it currently stands, successful small business owners face marginal tax rates in most states above 50% (besides state and local tax rates there is the phase-out of deductions and Medicare taxes boosting the effective marginal tax rate), which I think is the threshold between the tax code merely being annoying and beginning to seriously deter investment and economic activity. Another ten percentage points and it would result in a serious diminution of growth, as people spend excessive time and efforts trying to evade the punitive tax rates or, failing that, simply do less.

The corporate tax rate--which tax reform lowered to 34% in 1986--has also proven durable. It’s only been changed twice since then, and only barely, going up a percentage point in 1993 and then reduced for “manufacturing” firms by three percentage points in 2004.

This is important because--unlike 30 years ago, I would argue--economists realize that workers, not the shareholders--bear the brunt of the tax on capital via lower wages and fewer jobs.

Durability in this realm only does so much for our economy, however: Since 1986 every other country in the OECD--which includes the 32 most developed economies in the globe--has reduced its corporate tax rate, leaving us with the highest of any member country.  Since 2000 there have been over 100 significant corporate rate reductions among these countries, none of which were done by the U.S.

The band Maroon 5 reminds us that nothing lasts forever, a notion not unique to them but at least they managed to come up with a song celebrating that notion with a catchy melody and non-trite lyrics, albeit just barely.  But some things last longer than others, and it’s worth asking what precisely those things are when we manage to reform the tax code.