Tax Code Ripe for a Spring Cleaning

It’s indisputable that our Tax Code is an absolute mess.

The Code has grown so big that there are legitimate disputes about its actual length (3.4 million words seems to be the average). Such growth is “natural” as Congress begins to hand out favors (some well intentioned, others not) and special interests weasel their way in to beneficial loopholes.

To counteract the harmful effects of a Tax Code run amok, the federal government has traditionally done a “spring cleaning” every 15 years or so. The government initiated major tax reform efforts in 1954, 1969, 1976, and 1986. And then it hit a lull.

It’s now been 25 years since the last wholesale scrubbing of the Tax Code and as a result it is more junked up than ever. The steady build up of loopholes, deductions, credits, and alternate tax schemes lead individuals and companies to waste thousands of hours and billions of dollars making sure they don’t pay too much.

Fortunately, momentum is building for tax reform. Last week President Obama released his plan for corporate tax reform (he didn’t touch the personal side) and as we lamented, it’s a mixed-bag of mostly good ideas and bad policies. The Republican presidential candidates have also tipped their hands as to how they’d fix things on the corporate side as well.

Mitt Romney would reduce the corporate income tax rate from 35 percent to 25 percent and shift from an outdated “worldwide” system to a “territorial” one. Newt Gingrich would cut the corporate income tax rate to 12.5 percent and allow 100 percent expensing of new equipment. Rick Santorum would cut it to 17.5 percent, eliminate it altogether for manufacturers, and raise the Research and Development Tax Credit from 14 percent to 20 percent. Finally, Ron Paul would cut the rate to 15 percent and allow companies to repatriate foreign-earned income without additional taxation.

With a consensus forming that tax reform is necessary and yet nothing close to consensus on what needs to be done, it’s important to keep some core principles in mind. Fortunately, this past week the Organization of Economic Cooperation and Development (OECD) released a working paper investigating the “design of tax structures to promote economic growth.”

It’s a good read if you’re interested in this kind of stuff, but if not here are some of the more interesting tidbits I found:

  • “Corporate taxes are found to be most harmful for growth, followed by personal income taxes, and then consumption taxes.”
  • “Lowering the corporate tax rate and removing differential tax treatment may also improve the quality of investment by reducing possible tax-induced distortions in the choice of assets.”
  • “Evidence in this study suggests that lowering statutory corporate tax rates can lead to particularly large productivity gains in firms that are dynamic and profitable. . . It also appears that corporate taxes adversely influence productivity in all firms. . .”
  • “In the OECD area, the unweighted average corporate tax rate has dropped from 47% in 1982 to 40% in 1994 and 27.6% in 2007. The corporate tax rate reductions have been partly financed by corporate tax base broadening measures in many countries . . .”

From those data points it should be more clear than ever that the United States is playing catch up in the global race to become more attractive to businesses and investment.

While other nations have been actively lowering their corporate tax rates, dividend rates, and taxes on capital, the United States has stayed largely stagnant. In doing so, America has become relatively more wedded to the form of taxation that is the worst for economic growth. Moreover, we’ve likely left additional productivity gains on the table as we’ve twiddled our thumbs.

As the economy becomes more globalized and entrepreneurs, startups, and relocating businesses are trying to find the best environment for their needs it becomes all the more important that the U.S. revamp it’s thinking on taxes. Unless we want to be left out in the cold, we must be proactive in seeking to reduce our spending (and therefore, the taxes we require) in order to stay competitive. Moreover, whatever revenues remain necessary, the U.S. must do a better job in creating a tax structure that is less harmful to growth.

Each of the Republican candidates has laid out a framework that hews closely to the lessons laid out by the OECD. Now, it is our job to make sure one of them is elected to see them through.