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WebMemo #821 on Taxes

August 22, 2005

Fixing America's Tax Code

By

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Introduction:

The essays in this collection were originally written as part of a series in Investor's Business Daily about fixing the tax code. In the beginning, the biweekly newspaper columns served as an open letter to the President's Advisory Panel on Federal Tax Reform, which was in the spring of 2005 soliciting public commentary on how to fix the tax code. But as the columns developed from February through June, each one building upon the other, they became a plain-language "how-to" manual on tax reform -- how to go about it, mistakes to be avoided, and suggestions about what the final product might best look like. Hence, the decision to republish them as a short electronic book. This introduction summarizes some of the main points and expands upon others in ways that were not possible within the space constraints imposed on a newspaper columnist.

One recurring theme is that tax reformers should concentrate on commonsense solutions that work. That is, reformers should not indulge their egos and curiosity with experimental ideas that may sound good in an academic treatise but in real life are almost certain to have unknown and unwanted side effects. Another is that tax reform should concentrate first on removing saving and investment from the large amount of existing double taxation that needlessly constrains economic growth, costs jobs, and impairs living standards. By doing so, tax reform will allow all Americans a fair opportunity to become capitalists and thereby to enjoy that special kind of freedom that comes with being an owner.

Tax reform is central to the ongoing struggle between free markets and government.

The current tax code does exactly the opposite of what common sense says is in the best interests of the American people. It favors high rates of tax over high rates of GDP growth; consumption over saving; imports over exports; foreign investment over domestic; and mindless paperwork over genuine productivity.

The bad influences exerted by the tax code have powerful consequences that do great harm. Because we Americans save and invest too little, we produce too little and consume too much; and because our consumption is too high relative to our production, our imports are too high and our exports too low; and because we import more than we export, we must borrow from foreigners; and if we borrow from foreigners and also continue to consume too much, we must repay them with part of our savings; and when we deplete our savings, it is harder to invest and produce.

With all its mind-numbing complexity and wrong-headed rules, the tax code is emblematic of the entire body of federal laws and regulations on every subject imaginable. Thus, the stakes riding on successful tax reform are enormous. Because if the Congress and the President cannot (or will not) reform something so fundamental or readily fixable as the tax code, what hope is there for ever doing anything about the rest of the federal edifice, where the faults are much grander and reform is far more difficult to achieve?

Tax reform is not the complex, Herculean task that many have thought. The half dozen aberrations in the tax code that are most damaging to economic growth are also sources of much tax complexity. Remove the most egregious impediments to economic growth and get major simplification as a free byproduct.

Nearly all tax reform options eliminate the double taxation of saving, investment, and international trade, and, in the process, cut out big chunks of complexity as well.

If the dozen different IRA and 401(k) variations in the current code are replaced with a better alternative that really does eliminate the double tax on saving -- as tax reform promises to do -- the tax code and regulations will shrink by more than 1,100 extraordinarily complex pages.

Replacing the current code's half dozen different depreciation systems with simple and effective first-year expensing for machinery and equipment will cut out another 400 pages of code and regulations that put a double whammy on the economy: Not only do the existing depreciation rules impede investment and constrain productivity, they increase compliance costs enormously.

A straightforward exclusion of export income will moot another 100 to 200 pages occupied by several overlapping, partially irrelevant and generally failed "Rube Goldberg" schemes that have cluttered up the tax code for decades.

In addition to fixing the export situation (where U.S. businesses produce here and sell abroad), some tax reform options also do away with the tax code's archaic two-tax regime for income that is earned when a U.S. business both produces abroad and sells abroad in a foreign market. There are currently about 950 pages of rules about such "foreign source" income. Most hamper the ability of U.S. companies to compete in global markets. Few appear to raise any tax revenue. Critics say they cost tax revenue.

Experiments in the 1990s indicate that eliminating double taxation, in combination with other simplifications and a plain-English rewrite of the tax law, will reduce the size of the Internal Revenue Code by half.

Concentrating tax reform on eliminating double taxation also provides the most bang -for -the buck in terms of economic growth. For example, for each $1 of static revenue cost, switching from depreciation to first-year expensing will produce roughly $9 more GDP, and switching from double to single taxation of personal saving will produce $4 to $7 more GDP.

Successful tax reform has the capacity to help chart a new course for the 21st century -- one in which the economy is larger and living standards are higher as ever more people reap the rewards of market capitalism. And as fewer Americans depend on government paternalism, freedom will flourish.

But before tax reform can succeed, the Congress must undergo a considerable attitude adjustment. The Congress is aware of the damage the tax code is doing to America. And the Congress knows how to fix the problem. But the Congress has thus far refused to do it.

The American people should demand that the Congress get on with the job before more trillions of dollars of GDP are lost, before more jobs are lost and, in the case of some industries, before it is too late. And if the members of Congress do not act, the voters should hold them all to account in the next election.

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Ernest S. Christian is a former Treasury tax official and is now Director of the Center For Strategic Tax Reform in Washington, DC.

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