President Trump is going back to square one on tax reform. For the champions of his original tax plan — perhaps also for the president himself — this may be disheartening. But for those of us who want a simpler code and lower business and personal tax rates, this is great opportunity to revisit the best principles of tax reform and remind the administration of what not to do.
Former President Barack Obama and Senate Democrats defined tax reform the way Socrates' wealthy host Polemarchus defined Justice, as a way "to benefit one's friends and harm one's enemies." Health insurance CEOs should pay more than everyone else, and solar panel makers should pay less. Hike the Kochs' taxes to pay for tax incentives here and there.
It would be easy for the Trump to fall into this mindset, with his own slate of friends and enemies. But the proper aim of tax reform should not be to pick favored winners and losers but to minimize distortions that the tax code imposes on the economy. Simplicity and neutrality are the principles. Low rates are the payoff.
There was a telling and depressing story about the tax code in the middle of the Obama administration. The New York Times reported that General Electric paid approximately nothing in federal corporate income taxes in 2010.
"Minimizing taxes is so important at G.E.," the Times wrote, "that [company tax chief John] Samuels has placed tax strategists in decision-making positions in many major manufacturing facilities and businesses around the globe. … Company officials acknowledged that the tax department had expanded since he joined the company in 1988, and said it now had 975 employees."
It's proper and expected that GE try to minimize its tax bill — it employs 975 people to do just that — for the management owes this effort to shareholders. The egregious problem is that Congress has made gaming and navigating the tax code so profitable that a company would dedicate nearly a thousand souls on that task. The killer detail is that these GE accountants are in "decision-making positions," meaning that the company is investing not necessarily where consumer demand is, but where tax policy is preferable.
Thus the complex tax code distorts decisions that affect wealth creation, and thus shrinks the economy. The most productive activity might be taxed more than a less productive one, so businesses large and small rationally take the less productive but politically favored route.
These distortions pepper the individual code and the corporate code. If Congress removes the loopholes and tax breaks, that allows for a lower rate without sacrificing government revenue. Strip away the distortions and lower the rate, and you have a double-barreled pro-growth weapon.
It's easier said than done, of course.
There are many possible approaches to tax reform. Congress could opt for a serious overhaul, such as the Border Adjustment Tax Trump's team's originally considered, or the Viard-Toder tax plan which sets taxes on investment income equal to taxes on labor income in exchange for lowering the corporate rate. Simply reducing rates and scrapping deductions and credits might be easier.
But no matter what, a corporate income tax has inherent complications, because setting aside any special-interest tax credits, it's not always clear what counts as "profit." Depreciation versus expensing, last-in-first-out inventory rules, and other ambiguous questions mean the tax code will never be simple.
The exclusion of employer-sponsored healthcare plans is the biggest tax break, reducing revenues by $143 billion in 2014. The distortions of this provision are dramatic and well-known, but Republicans were unwilling to even trim this tax break during March's healthcare debate.
For corporations, the biggest single tax break is the Domestic Production Deduction, which reduces federal revenues by about $10 billion a year. Can a president who ran on a "Made in America" promise and who sings the praises of coal mining and oil and gas drilling really scrap this tax break?
The greatest difficulty, however, will be the tax lobby. Washington is crawling with former Treasury Department officials, former Ways & Means Committee chairmen, and former Finance Committee staffers, all of whom make a living from the complexities of the unreformed tax code.
Their job security is the annual expiration of tax extenders. Their value is their ability to locate, massage, and justify arcane tax provisions they wrote when in public service and helped further shape as lobbyists.
A simpler, revamped tax code could moot the relevance of these swamp creatures. Lower rates would lower the price companies are willing to pay to avoid taxes. Heck, GE might dismiss half of its tax battalion if the tax code were more straightforward.
President Trump promised to fight the special interests in Washington. Reforming the tax code will require him to do just that. Washington isn't broken because it's run by idiots, as Trump sometimes alleged on the campaign trail. Washington and the tax code are broken because it's run by political insiders, which he also recognized, who know exactly what they're doing.