On August 2, President Obama lost a yearlong campaign to leverage public outrage at growing deficits and debt into a massive tax increase. Republicans in the House and Senate kept their no-tax-hike pledge and demanded and won a $2.5 trillion spending reduction in return for giving Obama a higher debt ceiling.
So now Obama has publicly signaled that he views "tax reform" as a possible Trojan horse for the $1.5 trillion tax increase he's wanted all along. Obama did kinda tip his hand with a headline-grabbing promise that he would veto any tax reform that did not increase taxes. He will hold tax reform hostage to his demand for (cue Austin Powers) "$1.5 trillion."
In other words, Obama hopes that he can attach his boat anchor of a tax increase to the very real public demand to reform both the individual and corporate income tax systems. (An added benefit for Obama is that the threat/promise of tax reform can shake campaign contributions from hopeful or terrified businessmen.)
Today the federal income tax code contains 3,837,105 words. This is before the 21 new taxes in Obamacare hit our shores. One hint of what is to come: the "General Explanation of Tax Legislation Enacted in the 111th [Reid and Pelosi's] Congress" is 747 pages long. The instruction book for the 1040 "long" form is 179 pages long. The "short form" instructions run 87 pages. The Treasury Department estimates the paperwork burden driven by personal and individual income tax forms cost Americans 7.6 billion hours, or the equivalent of 3.8 million Americans working full time (two weeks of vacation allowed). Compare this "conscript army" of 3.8 million with our present Armed Forces of 1.88 million—1.02 million in the Army, 330,000 in the Navy, 330,000 in the Air Force and 203,000 in the Marines. The entire civilian federal workforce is 2.2 million.
David Keating of the National Taxpayers Union authored a study that calculates that the value of those man-hours is $227.2 billion each year. Of that total, $115.4 billion is for the individual income tax. Economist Art Laffer built on Keating's study and placed the cost at north of $431 billion each year—representing 30 percent of the cost of tax revenues.
Individual Americans are joined by the business community that views the 35 percent corporate income tax rate on American companies as crippling in international competition. The European average corporate income tax rate is 25 percent. The corporate rate in China is 25 percent.
THERE HAS LONG been a general consensus among conservatives on the ultimate goal of tax reform: government should tax consumed income one time at one rate. Taxing income at one single rate treats all Americans the same before the taxman. Progressive or graduated tax rates divide Americans into different classes that can be mugged one at a time. This has led to the strategy employed by both Bill Clinton and Barack Obama: the divide and conquer, "Richard Speck" theory of tax increases. If you cannot take on everyone in the room at one time, take them out of the room one at a time. Taxing income one time means watching you earn a dollar and seizing some (the flat rate income tax) or watching you spend a dollar and taking a cut (a national sales tax, popularly called the Fair Tax). Taxing income one time requires killing the death tax and eliminating the double taxation inherent in capital gains taxes and taxes on dividends.
Congressional Republicans enter the 2012 election with more unity and a clearer direction on tax reform than ever before. Paul Ryan's budget proposal would not only reform entitlements, welfare programs, and discretionary spending to save $6 trillion over a decade, but would also lay out the first steps toward fundamental tax reform.
When the dust settles after the 2012 election, it is most likely that the Republicans will win enough of the 23 presently Democrat-held Senate seats in play to pass Ryan's tax reforms through the Senate as well as the House. Yes, the presidential candidates all have plans of their own. And presidents are important when their own party has no coherent vision. But this Republican Congress needs a president to provide a signature, not a vision. In 2013 Congress will enact its tax reform agenda and any Republican president will sign the bill. And he will like it.
The Republican consensus around the first significant steps to tax reform are as follows:
First, both the top corporate and individual income tax rates must fall to 25 percent. American companies cannot be asked to continue to try to compete paying more than the European average. This has, not very surprisingly, the unanimous support of the business community. As a result, even Democrats give lip service to the importance of reducing marginal tax rates—on companies. Democrat support for lowering tax rates on big business appears at first to be out of character. But the modern Democratic Party is no enemy of big business—properly regulated, tamed, neutered, and fitted with a halter.
Republican tax reform would also bring the top individual rate to 25 percent. Here the Democrats, who can begrudgingly accept lower corporate rates, are bitterly opposed. That's because small businesses, the self-employed, and entrepreneurs pay the individual rate, not the corporate rate. The overwhelming majority of small business income is taxed as individual income. High individual tax rates are high taxes on new, small, and growing businesses. These businesses don't pay dues to the unions, they fight tort lawyers, they don't have the staff to cheerfully absorb new regulations. They are Republicans, or worse, Tea Partiers.
A Republican Party that cuts the corporate rate and fails to bring down the individual rate at the same time is dividing its base to the advantage of the Democrats.
Step two is moving from long depreciation schedules for business investment in plant and equipment to immediate expensing. This would eliminate more than 1,000 pages of the tax code, as lawyers and bureaucrats would no longer argue about whether a new computer can be depreciated over five years or three or seven. Congress has taken baby steps toward expensing by allowing it for small businesses under Bush, and Obama actually proposed one year of expensing in the December 2010 deal to extend the Bush tax rates. This would greatly reduce the cost of capital and simplify the code, and it has had bipartisan support in the past.
Step three is moving from our worldwide tax system to a territorial system. The United States is almost alone in imposing a worldwide tax system on its citizens and businesses. If a Frenchman earns money in the United States, it is taxed by us and not by France. If an American earns a dollar in France, France taxes it and the United States taxes it. This creates a disadvantage for Americans working abroad compared to other nationalities. It makes hiring Americans abroad more expensive. It is particularly damaging for companies that find themselves paying foreign corporate taxes and—when they bring money back to the U.S.—American taxes as well.
Today there is $1.2 trillion earned by American companies sitting overseas that is not brought back because it would be taxed at a rate up to 35 percent. We could immediately move to repeat the success of the Bush law in 2004 that allowed American firms to repatriate their earnings and pay only 5.25 percent. Then more than $300 billion returned. Today it could be three times as much.
And lastly, Warren Buffett has inadvertently suggested this reform: a new "tax me more" line on every tax return where any American who wishes to pay higher taxes can simply write an additional check. At least six states provide such opportunities for rich liberals to live up to their public preening. Few do.
OBAMA HAS PROMISED to veto any tax reform that is not a major tax hike. He knows this means that no real legislation will be enacted. Obama's interest in tax reform is political, certainly not economic. He will play both the politics of envy and Chicago-style fundraising.
The downside of debating tax reform for the next 12 months is not that something bad will pass…Republicans will not pass a tax increase. Rather, it's that Democrats will raise millions from corporate America by playing on their fears of losing tax deductions and will fool gullible K-Streeters with false promises of lower rates and repatriation of foreign earnings.
The only thing standing in the way of passing dramatic, real, job-creating tax reform in 2013 is the possibility that Democrats successfully use corporate America's hopes for and fears of tax reform to fund Democratic campaigns in 2012.