Republicans’ Tax Reform Plan Offers a Path Back to Economic Growth

The last time the nation undertook comprehensive tax reform a Millennial hadn’t even been born yet. The year was 1981 and, to give you some perspective of time, it was also the year that MTV was launched, that the CDC discovered the first cases of AIDS, that the original IBM computer was released, that Muhammad Ali retired, and that the first Indiana Jones was released.

It was also a milestone year for the Speaker of the House Paul Ryan.

“I got my driver’s license the last year we did tax reform,” the speaker explained. “With good comprehensive, across-the-board tax reform we really believe we can get the kind of economic growth we need, which will solve so many problems we have in this country. And fundamental tax reform is critical because now we have the worst tax code in the industrialized world, bar none.”

Ryan’s last point should be beyond debate. The status quo of the corporate tax code is simply unacceptable. It imposes a statutory tax rate of 35 percent, the highest in the developed world,  which hardly anyone pays because the code is riddled with tax breaks and credits that serve as rewards for good lobbying, not for being productive.

But the bigger problem is that the United States has simply failed to keep up with the international trend towards “destination-based” tax systems in which businesses pay taxes based on where there revenues are earned. We are one of the few nations left that have an “origin-based” or “worldwide” tax system, which taxes companies based on where their goods are produced. The problem with either of these approaches is that it taxes all the income of domestically-headquartered companies, including income earned from sales abroad.

That means that U.S.-based corporations are always going to be double-taxes. Once by the U.S. for creating a product here and selling it abroad, and another by foreign governments who tax sales of products in their country. To avoid the incentive for every corporation to put their headquarters elsewhere, the U.S. provides a credit for taxes paid to foreign governments. It also allows companies to defer tax liability on income earned on foreign activity until it is repatriated to the United States.

If that all sounds wildly complicated, it’s because it is. It’s a system created to solve the challenges of a particular time and place, but rather than evolve to meet current needs, it’s been patched and jury-rigged into a Rube-Goldberg machine that harms economic efficiency.

Republicans, led by Rep. Kevin Brady, are aiming for a solution that simplifies the code, promotes job growth, and increases the incentive for companies to headquarter and produce goods in the United States.

It accomplishes these goals by:

  1. Dramatically reducing the overall corporate tax rate and cleaning out the laundry list of economy-distorting credits, deductions and incentives.
  2. Eliminating the self-imposed export penalty by moving to a destination-based tax system that provides for a border adjustment so that exports are exempted from tax and imports are subject to tax
  3. Replaces the worldwide tax system with a system that allows for a 100-percent exemption for dividends from foreign subsidiaries so that U.S.-based companies can bring their profits home for investment

As Ernest S. Christian, one of the authors of Reagan’s tax reform package, writes in National Review, the Republican proposal is a good deal for America:

Together, these reforms will help make America the predominant manufacturing and headquarters hub for doing business in the global economy. The Tax Foundation projects that within ten years, GDP will be 9.1 percent higher, wages will be 7.7 percent higher, and there will be 1.7 million more jobs than under current law.

The logic is impeccable. Instead of building plants abroad and having to absorb the new U.S. import-tax adjustment when they sell back into the U.S. market, American companies will invest in U.S. plants built here at home. Tax rates will be low on their income from products sold into the ever more prosperous U.S. market. In addition, the tax rate will be zero when they export American-made goods from U.S. factories. For the same reasons, foreign-owned companies will flock to the U.S. — bringing with them new jobs and purchasing U.S. equipment for doing business here and around the world. (If they stay abroad and sell their foreign-made goods into the U.S. markets, they will be hit by the import-tax adjustment set out in the Ryan-Brady plan.)

The opportunity for tax reform is a once-in-a-generation opportunity that can’t be missed. There is simply too many lost jobs, lowered wages and reduced growth at stake for tax reform to fail. We’ve already waited 35 years since the last overhaul of the tax system. We can’t wait another 35.

Photo Credit: Kurtis Garbutt.