Tax Reform: No Hope for Change

President Obama has made a bold series of tax and spending proposals. In a reprise of the positions he promoted earlier in his tenure, his latest plans would tax the wealthy and Wall Street in order to spend more on poorer people and the middle class. The Republican-dominated Congress is not likely to embrace such proposals for any number of reasons, but especially because they fly in the face of the sort of reforms that have gathered bipartisan support in the past. Indeed, this push from the White House would seem to all but ensure the failure of reform this year.

The president is looking for a raft of benefits to middle-class and lower-income Americans. These include two years of free community college; a $175 billion tax cut for those in the middle class who pay taxes; legislation to guarantee a week of paid sick leave; larger earned income and child tax credits; and discounted mortgages. The government would pay the $235 billion estimated cost of those benefits, at least that part of the cost that would fall on the budget as opposed to employers and lenders, by raising taxes on the wealthy and on the investment community. The president would, for instance, increase the top tax rate on capital gains, from 23.8% today to 28%, and insist that heirs pay full capital gains when they inherit. He also would impose a fee on the assets of the top 100 financial firms in the country.1

Republicans, predictably, have criticized the initiative. Senator Orrin Hatch (R-UT), the new Senate’s top tax writer, complained that such measures would penalize “small business, savers, and investors.” He challenged the White House to stop pushing tax hikes and “start working with Congress to fix our broken tax code.”2 But aside from the usual partisan posturing—from both sides—a more fundamental resistance might reflect the conflict between these new proposals the bases for tax reform entertained by both sides of the aisle and, ironically, also President Obama.

On the personal tax code, the drift of thinking for many years would seek to reduce statutory rates and broaden the tax base by eliminating write-offs and other breaks. Such features dominated the bipartisan Bowles-Simpson plans commissioned by the president in 2010. Those proposals failed less because of this suggestion than because Republicans rejected their tendency to raise taxes overall and Democrats rejected to their imposition of spending restraint. Few objected to the rate cutting and base broadening. These proposals were so popular, in fact, that President Obama resuscitated them in his State of the Union address the following year. Republican-backed budgets proposed by Representative Paul Ryan (R-WI) followed this shared recommendation to reduce rates, broaden the base, and eliminate deductions. Then last year, Representative Dave Camp (R-MI) put forward proposals that also included these basic principles.3          

On the corporate code, the consensus for change has been even stronger. At every level of government, there is concern that the current tax code puts U.S.-based firms at a distinct competitive disadvantage in the global economy. The U.S. statutory rate of 35% is now the highest in the developed world. The difference is far from marginal, either. It averages between seven and 11 percentage points above those of other countries. All sides in the debate advocate a reduction in the statutory rate, with the elimination of tax breaks to make up some, all, or more than all of the difference in revenues, depending on how business-friendly the proposer is. The consensus is so strong to reduce the statutory rate that even President Obama and Rep. Camp are close on the matter. The president once proposed a 28% rate, while Rep. Camp sought a 25% rate.4

The other huge focus of reform is the treatment of overseas earnings. All in Washington seem to agree that the code’s insistence on taxing the worldwide earnings of U.S.-based firms, whenever they earn it, hurts the economy in two ways. Because payment is due on the repatriation, the rule creates a reluctance among U.S.-based firms to bring home their overseas earnings. These monies either accumulate abroad or are reinvested there, neither of which adds to American jobs nor increases the productive power of this economy. The second evil Washington’s tax code breeds is the increasingly popular practice called “inversion,” in which U.S.-based companies find ways to incorporate overseas where they can avoid the U.S. tax code for all but their U.S.-based earnings. Though so far the U.S. Treasury has sought only punitive responses to this corporate practice, even those in government can see it would improve matters to adopt the approach used universally by other developed countries to tax earnings only where they occur.5      

Much as such measures had gained support over the years, it was never likely that they would pass into law anytime soon. The partisanship within Congress and between Congress and the White House was too intense even before the president’s announcement, and is more so now. Even if the White House were open to the reforms it had previously endorsed, Republicans are reluctant to send the president legislation that could burnish his image, including legislation that suits its longer-term agenda. On the contrary, Republican would much rather send him bills that could embarrass him by forcing a veto. Nor is President Obama, in these last years of his administration, prepared to yield to Congress any more than he did during the past six years, which was precious little. Even if all parties were eager to make progress, tax reform has foundered on details so many times in the past that it could easily do so again in the future. If a new tax code was never likely, it is even less likely now.



Read more commentaries by Lord Abbett