Last night at the Republican National Convention, President George W. Bush called for tax reform and a "simpler, fairer, pro-growth system." These are good goals and should be the foundation for any reform of the tax code. The Heritage Foundation believes in four principles for fundamental reform, and the President touched on them:
Don't punish achievement and risk;
The tax code should not play favorites;
The tax code should be understandable, not arcane; and
Tax rates should be low so as to encourage economic growth.
Don't punish achievement and risk. A new tax code should minimize the impact of taxation on risk and achievement. A progressive tax rate-and especially a progressive tax rate combined with double-taxation of saving and investment-discourages investment and innovation, which is risky by nature, and thereby decreases capital formation. When the potential return of investing is reduced, entrepreneurs become less willing to risk their capital on new companies or business opportunities. High tax rates also discourage workers from more challenging work and longer hours because they keep less of what they make.
The tax code should not play favorites. The current tax code is unfair. It rewards and punishes taxpayers based on a variety of arbitrary factors, including marital status, family size, source of income, use of income, and saving habits. Should the tax code reward one family for having three children while it punishes another family with the same amount of income for having four children by subjecting that second family to the Alternative Minimum Tax (AMT)? Reform should eliminate the many credits that now exist to reward certain behavior, such as purchasing an SUV or an electric car.
Tax reform means lowering tax rates and broadening the tax base so that all income is taxed one time. Some Americans should not pay less in taxes simply because they choose to spend money on articles that the government subsidizes through tax preferences. Across the economy, lower tax rates encourage work and investment. Lower rates combined with a broader base are a more efficient, less distortionary way to achieve economic growth than targeted tax credits.
The tax code should be understandable, not arcane. The current tax code is needlessly complex, and this hurts economic growth. As the President noted, Americans spend over six billion hours filing their tax returns every year. No doubt most Americans would prefer to spend these hours more profitably, at work or at play, but the bewildering tax code trumps any alternative. And this complexity may be worsening. As if one tax return wasn't enough, more and more taxpayers are having to fill out two or more returns each year to determine whether they fall into the AMT trap or qualify for certain deductions, credits, or rates.
Tax reform should simplify the tax code and ensure that Americans only have to complete one tax return apiece. Almost $200 billion would be saved each year if Americans could do their own taxes instead of paying fees to tax accountants or buying tax software. The President's call to "simplify the federal tax code" should come as welcome news to taxpayers, who may well be confused by the over 1,100 different forms and publications that comprise the current tax code.
Tax rates should be low so as to encourage economic growth. The President should continue to lower tax rates. President Bush made a good start with his 2001 and 2003 tax reforms and is right to push Congress to make these tax cuts permanent. The President should continue to focus on tax rate reduction and elimination of double taxation on dividends and capital gains. Lower taxes help Americans achieve a better stand of living through economic growth.
The President should also look at reforming corporate taxation. American companies pay one of the highest corporate tax rates in the world, and this punitive rate is even imposed on income that is earned-and already subject to taxation-in other countries. Lowering the corporate tax rate will help American businesses create jobs and boost productivity. Ending the double-taxation of income earned in other nations will help American companies competing overseas to win greater shares of global markets. And reforming corporate taxation to eliminate taxes on overseas income will lessen the incentive for companies to move abroad or keep their profits overseas and out of the hands of the IRS.
President Bush's words on fundamental tax reform were a good first step. They addressed the issues of simplicity, fairness, and economic growth. Now the President must take the next step and propose an overhaul of the current tax system. When it comes time to enact tax reform, the President should remember the principles that he described in New York City last night.
Rea S. Hederman is Senior Policy Analyst in the Center for Data Analysis, and Daniel J. Mitchell is McKenna Senior Fellow in Political Economy, at The Heritage Foundation.