Most everyone agrees that the current tax code is outdated and holding back the economy. The question is what to do about it.
Updating the tax code should focus on removing or at least reducing the main impediments to economic growth.
The chief culprit is America’s unusually high corporate income tax rate. Currently topping out at almost 40 percent, it is the highest in the developed world. It puts U.S. corporations at a tremendous competitive disadvantage, leaving U.S. workers and investors — and the economy as a whole — worse off than they would fare under a more reasonable tax burden.
Any tax reform plan should drive the corporate tax rate as low as possible — if not get rid of it all together.
This would certainly help workers. Most of the recent economic research shows that workers actually pay a majority of the corporate income tax in the form of lower wages. A working paper from the Congressional Budget Office finds that U.S. labor bears more than 70 percent of the corporate income tax.
High corporate tax rates also make it harder for businesses to invest in new equipment, factories, and research and development. Slow investment caused by high and distortionary taxes further limits job creation and wage growth.
This isn’t some hidden truth known only to economists. Almost 80 percent of Americans understand that high corporate taxes both lower wages and encourage corporations to do business outside of the U.S. When polled, a majority of Americans also say the corporate income tax is too high and support lowering it.
Supported by economic theory and American sentiments, a 15 percent business tax rate, as proposed by President Trump, would reverse some of the negative economic consequences of the current system and help spur economic growth.
At 15 percent, the U.S. could have a tax rate well below the average of our major trading partners and would be a more attractive place to do business. A lower rate alone could mean an economy that is permanently 4.3 percent larger, according to a Tax Foundation estimate.
A second and equally important reform for economic growth requires simplifying the current tax treatment of business capital expenses. Although a less easily understood reform, allowing the immediate deduction of capital purchases could permanently boost the economy by an additional 5 percent or more.
Called “full expensing,” this reform would simplify the complex and economically harmful system of “depreciation” now in place. Simply put, depreciation makes capital purchases more expensive by not allowing the full cost to be realized for tax purposes until years later. Treating capital purchases as a current expense in the same way the tax code treats labor costs would allow for additional investment, job creation and economic growth.
In recent years, America has been losing the global competition for businesses. Prominent American firms, such as Burger King and Anheuser-Busch, have moved their headquarters overseas through a process known as corporate inversions. A lower corporate tax rate can help reverse the inversions. America can win the competition for international business by also moving toward full expensing.
Tax reform’s primary goal should be to reenergize economic growth. In addition to rationalizing business taxes, comprehensive tax reform should allow American families to keep more of the money they earn, instead of sending it to Washington. This should be done by applying simple and transparent low rates on a broad base that eliminates the double taxation of investment.
Furthermore, to keep taxes low now and in the future, Congress must also address the main drivers of current and future government debt. Entitlement and discretionary spending reforms are necessary to make tax reform sustainable in the long run. Without spending reforms, deficits will continue to grow, requiring even higher taxes in the future.
The time for tax reform is now. The current U.S. tax code impedes economic growth. Pro-growth reforms will also help mitigate high debt and growing deficits by getting the economy growing at normal rates again.
Lowering the corporate income tax rate, expensing and other reforms will reverse the tide of businesses leaving the U.S., increase domestic investment and ensure a more stable tax base. Economists and the American public agree that the current system of taxation is outdated and in need of serious improvement.