It’s not hard to find people in Washington who say they favor something called “fundamental tax reform.” President Barack Obama, for example, loves talking about the idea. In a major speech at George Washington University and in each budget he has put before Congress, the 44th president has said he wants to “reduce spending in the tax code, so-called tax expenditures” (a good idea, though it strains credulity to suggest that letting people keep more of their own money is “spending”). Without offering any specifics, the president also has endorsed efforts to lower statutory corporate tax rates, while keeping corporate income tax revenue stable by eliminating credits, deductions, and exemptions.
GOP plans—even those in the supposedly radical, House-passed, Paul Ryan-authored “Path to Prosperity”— involve similar base-broadening cuts in the corporate rate and promise to do away with some unspecified “loopholes.” These “radical” Republican plans would probably be better for growth but actually share a lot of features with President Obama’s proposals.
While Democrats and Republicans agree that America needs to reform its corporate tax code, both sides have offered plans that essentially nibble around the edges by reducing carve-outs and lowering statutory rates. This isn’t fundamental reform. Indeed, the best one can hope for in any reform that emerges in 2013 would be something resembling the Ronald Reagan/Dan Rostenkowski/Dick Gephardt/Bill Bradley effort in 1986. The Tax Reform Act of 1986 was a well-thought-out bipartisan simplification of a shaky federal tax structure, yet the code quickly morphed into the 3-million-word mess we have today, loaded with special favors and loopholes of the very sort that Reagan-era leaders fought to remove.
A truly fundamental reform would be outright elimination of tariffs and corporate income taxes, two features of the tax code that nearly all right-of-center economists—and a surprising number of left-of-center economists—believe are damaging to growth and prosperity. Call it an “open for business” tax strategy, welcoming global capital to our shores and thereby stimulating the domestic economy.
Tariffs, which are just import taxes, are an anachronism that hurts consumers and the overall economy. While industrial unions and some of the older smokestack industries love the protection of tariffs, few economists of any ideological stripe would endorse them today. The NAFTA and CAFTA trade deals have eliminated most tariffs between the United States, Canada, Mexico, and much of Central America, but duties imposed on products from other countries raise prices for consumers and encourage misallocation of productive capacity.
The burden of tariffs falls most heavily on lower-income consumers, who spend relatively large portions of their income on overseas-produced and heavily tariffed goods like clothing and food. Furthermore, the relatively low-wage jobs that tariffs could theoretically “preserve” frequently come at the expense of new jobs that otherwise would have been created in more dynamic and remunerative sectors of the economy.
Moreover, for all the trouble they cause, tariffs bring in a relatively paltry $30 billion in revenue, less than 1 percent of the federal government’s total take. Their elimination could easily be financed by closing a handful of loopholes that few would miss, such as tax subsidies for wind energy boondoggles and mortgage interest on multi-millionaires’ mansions. Because tariff rates are reasonably modest, eliminating them might not make a huge difference for the economy as a whole. But the move would send a powerful signal to anyone seeking to do business with Americans while providing a counterweight to protectionism here and abroad.
The elimination of tariffs remains a topic of interest primarily to professional economists. In contrast, lots of people are talking about corporate tax reform. Alas, the reforms under consideration would be fairly minor. Democrats and Republicans alike want to end a variety of deductions and credits to lower the statutory corporate tax rate, but the most commonly proposed changes would fail to lower rates to levels that are competitive by international standards.
By any measure, America’s corporate income tax code is among the most burdensome in the world. The marginal rates are the highest of any industrialized country and effective rates are higher than all but a handful of First World economies. Even if America is very aggressive in broadening the base and lowering rates, it’s likely that it will only move to the middle of the First World pack. For a country aiming to be a global leader, “average” shouldn’t be enough.
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