Tax Reform Would Be the Best Form of Tax Relief

Anyone watching the Republican presidential debates over the past few months should be able to discern a common theme. Yes, aside from the insults, invective and internecine sniping, Republicans are united behind a common cause: They want to cut taxes.

This should come as no surprise. Ever since the supply-side revolution of the 1980s and enactment of the Tax Reform Act of 1986, the GOP platform has been much simpler than any actual tax-reform proposal: Tax cuts, über alles.

Don't get me wrong. I'm all for lower taxes, but some perspective is in order. If you glance at a historical table of individual income tax rates, what jumps out at you is how low today's top rate of 39.6 percent really is. With a few exceptions - the latter half of the 1920s (25 percent); 1988-1992 (28-31 percent); the last decade (35 percent) - the current rate is the lowest since the 16th Amendment to the U.S. Constitution authorized Congress to levy "taxes on income from whatever source derived" in 1913. 

Considering that the number of workers for each Social Security beneficiary has dwindled from 16.5 in 1950 to 2.8 today, the only surprise is that tax rates aren't higher. Which is why the GOP candidates should focus on tax reform, not tax rates.

During the 2008 presidential election campaign, Republican hopeful Herman Cain introduced his 9-9-9 plan, which would have replaced the individual, corporate, capital gains, payroll, estate and gift taxes with a 9 percent flat rate on individual income, corporate income and sales. 

I responded to Cain's 9-9-9 plan with my own idea for a tax system adhering to the "Three F's": Flatten it, fix it (i.e. set it in stone) and forget it. (The column is no longer available online.) First, I reviewed some first principles of taxation. Income tax rates should be designed to raise enough money to meet the legitimate needs of government. (Bernie Sanders and Thomas Jefferson may disagree on what constitutes "legitimate.") They should promote economic growth, not punish success. And they should be low enough to discourage non-economic activity, such as shifting or sheltering income to avoid tax liability.

Despite the huge swings in the top marginal rate in the post-World-War-II era - from a high of 92 percent in the early 1950s to a low of 28 percent under President Ronald Reagan - federal receipts as a share of GDP have been surprisingly stable at about 17 percent. If the revenue slice going to the federal government remains unchanged, why fiddle with tax rates? The appeal of the Three F's should become evident.

Why is the government unable to raise more revenue by increasing tax rates? Because the rich don't passively hand over a greater share of their income when the rate goes up. They find ways to shelter income by establishing trusts or moving money offshore. They hire high-priced tax attorneys to exploit the loopholes in the 74,000 page tax code.

The same is true for businesses. Even though many U.S. corporations don't pay the statutory 35 percent corporate income tax rate, this is not a good argument for retaining the highest rate among developed nations. General Electric, which recently announced it was moving its headquarters from Connecticut to Massachusetts for more favorable tax treatment, made headlines in 2011 when it filed the equivalent of a 57,000-page tax return and paid no taxes on $14 billion of profits in 2010. 

Imagine if GE's 975-person tax department directed its considerable analytical talents to a more productive line of work. That's why any meaningful tax reform must remove the incentive to pay so much to so many to avoid paying more to the U.S. government.

All of the 2016 GOP candidates have pledged to reduce tax rates. How they would do it and what it would cost are still sketchy at this stage of the campaign. Rand Paul, Ted Cruz and Ben Carson favor a flat rate on ordinary income. Paul and Cruz also support some form of a value-added tax on business activity, which, once instituted, tends to keep rising, as Diana Furchtgott-Roth explained in a column last week. 

Many of the candidates want to reduce the number of income tax brackets and lower the rates. Any promise to eliminate loopholes comes with a caveat: "with some exceptions."

Governor Mike Huckabee is the only candidate who would effectively do away with tax loopholes by eliminating the income tax altogether. Huckabee is a long-time supporter of the FairTax, a national retail sales that would not only replace the income tax but also abolish the Internal Revenue Service, which Huckabee says is his best audience applause line. 

The real hurdle to tax reform is the special interests that benefit from the various carve-outs. These are the same special interests the candidates court as donors and supporters. The wealthy, who benefit the most from tax preferences, devote substantial resources to assure their longevity. Hence, tax reform is a pipedream.

A few years ago, the Campaign to Fix the Debt, a non-partisan group of deficit hawks, announced with great fanfare that 100 business leaders, including GE's Jeffrey Immelt, had signed a petition supporting an effort to address the nation's burgeoning debt. Some of the CEOs gathered at the New York Stock Exchange on Oct. 25, 2012, to ring the opening bell. They held several telephone press briefings to garner support. 

On the calls, I heard all the usual platitudes - "shared sacrifice," "for the good of the country" - but little in the way of specific proposals. I wanted to know which of the CEOS would be the first to commit publicly to end all lobbying for industry- and company-specific tax breaks. Silence, some laughter, no volunteers.

When it comes to real sacrifice, shared or otherwise, no one, it seems wants to be the first-mover - especially when moving first yields no obvious advantage.

Caroline Baum is a contributor to e21. You can follow her on Twitter here.

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