Scrap the Code

In the last few weeks, talk of President Bush’s soon-to-be unveiled second term economic agenda has shifted, for the first time in a long time, to a discussion about fundamental tax reform.

First there was the release of Speaker Hastert’s new book in which the Illinois republican explains that taxes account for 23 to 27 percent of the cost of our goods and services, putting our corporations at a competitive disadvantage with our trading partners. Thus, he argues, “For us to return capital and jobs to the United States, we’re going to have to change our present tax system and adopt a flat tax, a national sales tax, an ad valorem tax, or VAT.” I agree we need to fundamentally reform the tax code, however, I have always worried that a VAT is too easy to increase, which we have witnessed in Europe.

Later in the week, Sen. Sam Brownback, R-Kans., said that President Bush is committed to a growth platform, and that “you’ll start hearing him talk about a flat tax, really getting the tax code out of so much impact over peoples’ lives.”

Alan Murray wrote in the Wall Street Journal that the Bush administration is taking another page from the Gipper’s playbook – tax cuts in the first term, tax reform in the second.

If fundamental tax reform becomes the issue, and I believe it to be a huge issue, it is important that we clearly articulate what exactly that means. By 1986, Ronald Reagan succeeded in bringing the top marginal tax rate down from 50 percent to 28 percent. But, the mistake made was increasing the capital gains tax rate to 28 percent and treating capital gains as identical to ordinary income. The result: capital gains tax revenue, which was greater than $165 billion in 1985 dropped precipitously to $116 billion in 1992. The trouble is capital gains is not ordinary income, it is a tax on putting surplus capital at risk. It is a direct tax on wealth creation and risk capital – which only slows growth and reduces revenues.

In 1996, the last time fundamental tax reform received a concerted public hearing was when I chaired the National Commission on Economic Growth and Tax Reform – the Kemp Commission. We ultimately decided the income tax system was “impossibly complex, outrageously expensive, overly intrusive, economically destructive and manifestly unfair” – in short, we concluded the best course of action was to scrap the code altogether and tax all income, but tax it only once – this would radically simplify taxation and create the conditions for long-term robust economic growth.

Since the Kemp Commission, capital gains tax rates have been reduced twice, in 1997, and again with the 2003 tax rate reductions, thanks to President Bush. Individual income tax rates have also declined as a result of the Bush tax cuts, but the current top rate of 35 percent is still well above the 1986 level of 28 percent. What’s worse, the pro-growth elements of the 2003 tax cuts are set to expire, with some provisions expiring at the end of this year.

Moreover, we still have a tax code that begins with an overly broad definition of taxable income. As a result, we have been forced to create a number of deductions, credits, exemptions – what John Kerry would deride as loopholes – to try to ameliorate some of the perverse disincentives from such an ill-conceived cradle-to-grave, redistributionist, social-engineering-focused tax system. The system is still impossibly complex, outrageously expensive, overly intrusive, economically destructive and manifestly unfair, and we should still scrap the code.

On the corporate tax front, America is falling farther and farther behind. In 1986, the United States cut the federal corporate tax rate from 46 percent to 34 percent. Since then, the rest of the world has caught up and surpassed the United States in corporate tax competitiveness. Today, the United States has the fourth highest corporate tax rate among Organization of Economic Cooperation Development countries, roughly 10 percent more than the average OECD top corporate rate – further proof that the real problem facing American job creation is not “Benedict Arnold CEOs,” as John Kerry maintains, but a confiscatory, confusing and overly complex tax system.

If we cannot scrap the code outright, then we should, at a minimum, make permanent the 2001 and 2003 tax rate reductions; we should continue to reduce the double and triple taxation of savings and investment; we should reform the increasingly destructive alternative minimum tax; we should bring down the individual income tax rates to at least 1986 levels; we should reduce our level of corporate taxation to become competitive internationally; and we should enact National Enterprise Zone legislation to demonstrate the powerful economic impact of fundamental tax reform.

Surely the first objections of deficit hawks in both parties will be that we can ill-afford another round of tax cuts. To them I would say, listen to the sound advise of John F. Kennedy who argued in 1960, “It is increasingly clear that no matter what party is in power, so long as our national security needs keep rising, an economy hampered by restrictive tax rates will never produce enough revenues to balance our budget, just as it will never produce enough jobs or enough profits. Surely the lesson of the last decade is that budget deficits are not caused by wild-eyed spenders but by slow economic growth and periodic recessions, and any new recession would break all deficit records.”

My question is why isn’t John F. Kerry listening to or at least reading John F. Kennedy.