There can be no going back.
With the Obamacare fight all but over, all eyes have turned to tax reform. This week, President Trump unveiled the “Unified Framework for Fixing Our Broken Tax Code.” That’s good news for taxpayers, consumers, and businesses. The current tax code is burdensome and inefficient and thwarts efforts to revitalize the economy. The new plan for reform includes an overhaul that makes the tax code simpler, fairer, and flatter. The plan touts benefits to the middle class, small business, and the economy as a whole. This is a fundamental upgrade from the current tax code, which is collapsing under the weight of all the loopholes and carve-outs that have been piled on over the years. The proposed tax plan is an attempt to clear out the underbrush and create a new tax code based on economic common sense rather than political expediency.
The plan has something for all taxpayers, and the current seven tax brackets are simplified to just three: 12 percent, 25 percent, and 35 percent. To ensure that lower income families are held harmless with the elimination of the 10 percent tax bracket, the plan also doubles the standard deduction and boosts the child tax credit. While the mortgage interest deduction and charitable deduction remain, the goal is to close as many other loopholes as possible. Gone also is the death tax, an inefficient tax that raises little revenue. And for added simplicity, the Alternative Minimum Tax is also eliminated.
When it comes to business, the tax plan includes three fundamental changes that should facilitate economic growth: lower rates, a five-year window of full expensing, and a territorial system that makes American companies more competitive in a global market.
Lowering corporate rates is a good place to start. With a top corporate rate of 39 percent, the United States has the highest rate among OECD nations. Cutting the rate makes economic sense, and the new plan proposes a corporate tax rate of 20 percent. Small businesses will also see favorable reforms, including new rules that limit the maximum tax rate for small businesses run as sole proprietors, S corporations, or partnerships to 25 percent.
While lower rates are a definite benefit to businesses, full expensing is an idea that will provide an immediate boost to economic growth. Basically, full expensing allows a company to write off a capital investment immediately, rather than depreciating it over time. Under current law, asset depreciation follows arcane schedules laid out in the tax code, and these vary by industry and sector of the economy. These different schedules are more a function of political influence rather than economic efficiency. Full expensing simplifies this and the five-year time frame provides an incentive for immediate investment, expanding output and job growth.
Adopting a territorial system of taxation makes American companies more competitive by allowing them to play by the same rules that most foreign companies face when dealing in the global market. In fact, the United States is the only major economy that uses a worldwide tax system instead of a territorial system. This discourages companies from repatriating their foreign earnings. Putting American companies on equal footing with their competitors is an important improvement.
There is much to like in the framework work for tax reform. But the road to implementation will be challenging. The proposal was created by leadership from the House, Senate, and administration, so there’s a consensus on the starting point. However, the plans for closing loopholes and carve-outs will no doubt trigger alarm bells across Washington, creating formidable opposition bent on derailing reform and protecting the status quo. It will take leadership and coordination between Congress and the executive branch to make sure this unique opportunity for reform is not squandered. The stakes are high and the benefits for taxpayers and the economy are real. At the same time, the costs of failure are also high: the status quo is broken and the current code is an unwieldy product of special interests and politics that threatens economic growth. It is well past time for fundamental tax reform that offers a simpler, fairer tax code.