Current tax proposals by Republican leadership include separate tax rates for small business income, capital gains, and dividends. That idea is contrary to President Ronald Reagan's tax reform principles of adding simplicity and fairness to the tax system.
In President Reagan's bipartisan Tax Reform Act of 1986, all items of income were subject to the same tax rates. Did Mr. Reagan and a bipartisan Congress get it all wrong in 1986, after laborious research and lengthy hearings?
Some individuals may be lulled into thinking that fewer tax brackets translates into a big step toward simplification. It really isn't. Even with numerous tax brackets, all one has to do is determine very easily which bracket taxable income falls within, and then make the calculation.
The complexity derives from having different tax rates for different sources of income. As an example, recently I helped an accounting student manually fill out Form 1040 that included a small amount of long-term capital gains. The process was onerous and laborious, rife with special forms and IRS worksheets — an enormous amount of complexity that certainly is not offset by having three tax brackets versus seven.
In the General Explanation of the Tax Reform Act of 1986, the authors expressed a rationale for eliminating reduced taxes for long-term capital gains. That same rationale for simplicity should be applicable today.
"This will result in a tremendous amount of simplification for many taxpayers since their tax will no longer depend upon the characterization of income as ordinary or capital gain."
In addition to simplification, providing the same tax rates for all types of income increases the important aspect of fairness to the tax system. As the Senate Finance Committee put it in its final report on in 1986, "It is difficult for the committee to find fairness in a tax system that allows some high-income individuals to pay far lower rates of tax than other, less affluent individuals."
Following the rationale of the Senate Finance Committee in 1986, it is extremely unfair that under current tax law and under the proposed tax proposals, most ordinary wage earning taxpayers end up subsidizing other taxpayers who receive low tax rate capital gains and dividend income. A Pew Research Center study last year revealed that the estimates for fiscal 2016 included a loss of tax revenue of $134.6 billion due to "lower tax rates on dividends and long-term capital gains," which was the projected second largest source of lost tax revenue.
Investments in new business ventures and in stocks did not cease after President Reagan and Congress passed the 1986 tax act. There is little reason to think that those investments will slow down significantly if individuals have to pay the same tax rate on small business income, dividends, and capital gains that they have to pay on wage income.
The old saying is that a bird in the hand is worth two in the bush. If capital gains, dividends, small business income, and wages are taxed at the same rates, we would have a strong bird in the hand, representing simplicity, fairness, and agreement with Reagan's and a bipartisan Congress' tax reform ideas. The two birds in the bush represent possible but not guaranteed new jobs, and economic growth based on rosy projections.
Reagan and a bipartisan Congress got it right in 1986. They did more than pay lip service to the principles of simplicity and fairness that should be timeless and should not be outweighed by pie in the sky visions of new jobs and super economic growth. Don't throw Reagan's tax reform principles under the bus!
David Nelson is a former tax partner at Ernst & Young.
If you would like to write an op-ed for the Washington Examiner, please read our guidelines on submissions.