Business Ethos Blog

What Should Be the First Priority? A Case for Tax Reform

Dr. David Mielke, Retired Dean of the College of Business at EMU

Republicans are bound and determined to pass legislation repealing and replacing Obamacare before they pass tax reform.  The legislation House Republicans have offered is facing major pushback from both Republicans and Democrats leaving tax reform in limbo.  The stock market has experienced what could be called an expectation rally based on the promise to enact tax reform, reduce regulations and to pass an infrastructure bill.  Has the rally been based on expected health care reform?  Will health care reform have a more positive impact on the economy than tax reform?  The House released a blueprint last year that is serving as a starting point for that legislation.  What are the main ideas in the initial tax proposal and are there already problems with it that require full attention of Congress? Should Congress put the health care bill on hold and instead focus on what will really make a difference in the economy—tax reform?  What is the “Right Thing to do?”  Let’s look at some issues:

  1. The basic provisions of the tax reform blueprint include the reduction of the corporate tax rate to 20%, a one time tax of 10% to allow corporations to repatriate the almost $2 trillion of foreign earnings and to return that cash to the US and to reduce individual tax rates and compress the rates into just 3 brackets.
  2. The tax reform blueprint has already encountered objections, primarily due to the proposed Border Adjustment Tax which would allow companies to export without paying any taxes on export profits and to charge a 20% tax on any imports.
  3. There are 4 stated objectives of the Border Adjustment Tax: to encourage US exports to improve the US balance of trade, to help prevent US companies from moving operations and jobs abroad, to encourage foreign corporations to locate and produce products here for the US market rather than import to the US and to raise additional tax revenue of $120 billion taxing imports to make the overall reduction in corporate taxes revenue neutral, that is not increasing the US deficit.  That $120 billion will be passed on to consumers eventually.
  4. The main objection to the Border Adjustment Tax is that it would increase the cost of all imports by 20%, impacting consumer prices.  Advocates of the tax expect that the value of the dollar would increase, some say by 25%, which would result in lowering import costs, thus nullifying any price increases.
  5. Critics claim that the impact on consumer prices would especially hit imports of food such as coffee, tea, spices, chocolate, bananas, seafood and other fruits and vegetables which cannot be produced in the US.  In addition, imported oil costs would increase, possibly raising gasoline prices by 20 cents a gallon.
  6. The proposal also would eliminate the corporate deduction for interest expense, reducing the incentive for companies to borrow and finance their investments by issuing bonds and borrowing from banks.
  7. As an offset to the interest expense deduction, businesses could immediately write off the costs of capital investments, thereby encouraging companies to invest in new technology, plant and equipment.
  8. The GOP would also eliminate special interest business tax preferences and tax credits for things such as renewable energy, low income housing and employment.
  9. On the individual side of the tax code, the highest rate would be reduced to 28% from 33% now and also reduce all other bracket rates.  All itemized tax deductions would be eliminated except for mortgage interest and charitable contributions.  Those states with high property taxes object because that deduction would be eliminated.
  10. Any changes in the tax code whether for corporations or individuals are likely to make some groups unhappy.  Other critics are concerned that tax reductions will increase the deficit.

Since tax reform faces many obstacles, should the Republicans be using their efforts and the President using his political capital to promote tax reform rather than fight for health care reform right now?  Does it make sense to include a Border Adjustment Tax impacting import costs and potential price increases for consumers?  Even if the dollar appreciates to reduce the cost of imports, will it be enough to offset the 20% tax? Will there be disruptions in a variety of industries even if the dollar appreciates and how long might that adjustment take?  Is the import tax necessary to make the tax reductions revenue neutral?  Is it time to eliminate certain corporate and special interest tax deductions and to simplify the tax code by minimizing individual tax deductions?  How long do corporations and individuals have to wait while the health care battles rage before tax reform and the many battles that faces will become the top priority in Washington?  What is the “Right Thing to do?”  Tax reform should have taken and should now take center stage and move forward.  Will the Republicans have the energy and resolve to move forward and fight new battles on tax reform after fighting an exhaustive fight on health care?  The tax reform should eliminate the Border Adjustment 20% on imports.  Prices on imports, with consumers particularly hard hit, will go up.  The dollar appreciation, if any will take a long time to have an impact.  Allowing investments to be immediately written off provides a greater incentive to invest than is provided through interest deductions.  They should be eliminated along with special interest credits and deductions.  Individual rates should be reduced and deductions eliminated except for mortgage interest and charitable contributions.  Straightforward corporate and individual tax reform is needed now.  A perfect example of how this can work and avoid adding to the budget deficit is the 1986 tax reform.  The 1986 reform stripped out deductions and credits and reduced top individual rates from 50% to 28% and the corporate rate from 46% to 34%.  The economy boomed and the total amount of tax collections after the reductions were essentially the same as before.  This can happen again.  What should be the first priority for the economy?  Health care reform or tax reform?