Tax Reform Will Boost the Economy, Consumer Income

Tax Reform Will Boost the Economy, Consumer Income

We’ve frequently blamed the low growth of the U.S. economy on the tax code and excessive regulation, which have both been targets of the Trump Administration.

The current U.S. tax code has provided incentives for corporations to relocate their headquarters abroad and it’s held back economic growth. It has benefited lawyers, accountants, lobbyists and the special-interest groups they represent, to the detriment of everyone else. It has resulted in half of the country paying no income tax and, combined with excessive spending, has helped boost the federal deficit to $20 trillion.

It needs to change.

Tax Reform + Deregulation = Growth

Progress made on deregulation and expectations for the passage of tax reform may already be driving economic growth to 3% or even higher, which is a 50% improvement over the past eight years. Economic growth, if it is sustained, will in turn help investors by strengthening the stock market, improving consumer income and producing more tax revenue, which will help control the annual deficit.

An analysis reported in The Wall Street Journal concluded that regulatory risk for corporate America increased nearly 80% during the past six years, causing a drop in both corporate investment and employment. Separately, the Mercatus Center at George Mason University found that the least regulated industries outperformed the most regulated industries.

While deregulation is already taking place, the major focus recently has been on tax reform. What’s being proposed and how will it affect you? Is it fair? We’ll start by reviewing proposed changes in corporate taxes this week, then turn to consumer tax reform next week.

World’s Highest Corporate Rate

A problem with the tax code that we’ve highlighted several times is that the U.S. has the world’s highest corporate tax rate, which creates a competitive disadvantage, especially when the dollar is strong.

We’ve also noted that the U.S. is virtually the only country that taxes corporate profits when they are returned to the U.S. Because they are taxed in the country where the profits are earned, then again when they are transferred to the U.S., they typically remain abroad.

Because the U.S. corporate tax rate is the highest in the developed world at 35% (compared, for example, with 12.5% in Ireland) and because businesses are double-taxed when they return profits to the U.S., U.S. corporations have at least $2.5 trillion parked abroad.

One impact has been the phenomenon of inversions, in which U.S. companies purchase foreign companies, then move their headquarters abroad to escape taxation.

Returning that money home would potentially add new tax revenue, while increasing the availability of funds for investment in capital investments that could increase productivity, profitability and business growth.

Tax reform legislation was quickly approved in the U.S. House of Representatives and is set to be considered in the U.S. Senate after the Thanksgiving break. Both House and Senate bills would exempt most foreign income from taxation and reduce the corporate rate to 20%.

Ironically, many members of Congress who accepted $1 trillion a year budget deficits during the Obama Administration are arguing that tax reform will increase the federal debt.

However, when tax rates drop, businesses have less of an incentive to find loopholes and avoid paying taxes. The National Bureau of Economic Research found that each dollar of corporate taxes that’s cut returns 50 cents in new revenue, while each dollar of consumer taxes that’s cut returns 17 cents.

So here’s another irony. If enough tax loopholes are eliminated as rates are cut, tax reform could boost tax revenue.

Corporate Taxes Favor the Politically Connected

In spite of the high corporate tax rate, currently some large corporations pay little or no taxes. A study by the Government Accountability Office found that 43% of companies with more than $10 million in assets pay no corporate income taxes. As Forbes contributor Chuck Jones wrote, in recent years, Apple has paid taxes at a rate of about 25%, Microsoft’s rate has been about 16% and Alphabet’s (Google) has been about 19%.

The GAO explains that, “Reasons why even profitable corporations may have paid no federal tax in a given year include the use of tax deductions for losses carried forward from prior years and tax incentives, such as depreciation allowances that are more generous in the federal tax code than those allowed for financial accounting purposes.”

While neither the House bill nor the Senate bill would eliminate deductions and loopholes, both would reduce them. The Journal notes, for example, that, both bills “include measures to prevent companies from loading up on debt in the U.S. (where interest is deductible) to capitalize foreign companies. The Senate establishes a slightly stricter limit on interest deductibility on debt that is issued to foreign affiliates, but both bills would curb the practice of earnings stripping that the Obama Administration sought late last year to stop with regulations.”

We would like to see virtually all deductions and subsidies eliminated, which would be the fairest approach possible, but there are too many powerful lobbyists and special interests to expect that to happen. Maybe some of you would like to continue to subsidize the purchase of Teslas by Hollywood celebrities, but keep in mind that when one special interest group is subsidized, the rest of us pay more.

Small Businesses Would Benefit

Small businesses are generally taxed differently than large businesses. In fact, taxes are one reason there were more business failures than business start-ups after the financial crisis and throughout the Obama Administration.

According to the Tax Foundation, 90% of small businesses are pass-through entities, where the income produced by the business is accounted for in the owner’s personal tax filings.

“Research from 2010 has shown that the typical small business owner makes anywhere from $35,000 to $75,000 per year — reasonable numbers even today considering that the vast, vast number of small businesses are merchants, restaurateurs and operators of very small mom-and-pop firms, freelancers and independent contractors,” according to The Washington Post. “The House bill will (after some last minute changes) allow most of these business owners to take advantage of a tax rate of 9% on their first $75,000 of income with a cap of 25% on the rest.”

Deregulation along with more favorable tax treatment should help create more business startups. Given that small businesses produce more jobs than large businesses, and lack the advantages enjoyed by large companies, relief for small businesses would be very welcome.

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