This article first appeared in Larry Summers' blog.
I have been very sharply critical of what I regard as unprofessional exaggeration by advocates of the Trump tax proposal. Reasonably enough, people have asked what I am for.
I strongly support tax reform in general and especially corporate tax reform on the model of the highly successful bipartisan 1986 tax reform, which achieved very large rate reductions, spurred economic growth and improved the efficiency of the economy while being revenue and distribution neutral.
Although one could imagine all sorts of radical Blue Sky tax reforms — or much less radical ideas like a carbon tax or a value added tax — in the context of the current debate about how to make some alterations to the current tax system, I would suggest the following five elements in the spirit of 1986:
1. Reduce rates but not revenue. A core principle in 1986 was that rate cuts had to be financed by base broadening such as mortgage and health deductions and scaling back unwarranted business write-offs. This ensured that the beneficial effects of rate cuts were not offset by the risks of larger deficits. I have been a major proponent of deficits and fiscal expansion to spur recovery but now, when unemployment may fall below 4 percent and the Fed is tightening, is not the time to expand the long-run deficit. Larger budget deficits would mean larger trade deficits with the attendant costs and less space for government to respond to the next recession.
2. Broaden the corporate base by limiting international sheltering. Revenue is foregone and the economy is hurt when companies are permitted to avoid taxes on profits earned abroad by relocating them in Ireland, the Cayman Islands and other jurisdictions and building up cash. A U.S. company that benefits from U.S. commercial advocacy, U.S. negotiations on its behalf, U.S. research and development and so on should pay a minimum tax on its foreign income of 15 to 20 percent. At the same time, the Treasury should work with Congress to prevent transfer pricing abuses and to limit tax shelters that do not have economic substance.
3. Work to increase neutrality across investments and means of financing. The tax system as now structured encourages leverage because interest payments on debt are deductible and dividend payments are not. There are also biases between investments with different depreciation lives. Moving toward limits on interest deductibility in situations like many private equity deals where debt has equity-like risk premiums would raise revenue and increase financial stability. Any disincentive to investment could be mitigated by an increase in the share of investment that could be expensed — a step that would also increase investment efficiency.
4. Attack tax shelters. The most powerful driver of change in 1986 was stories about corporations reporting huge profits to shareholders on their 10k and then paying no taxes. At a minimum, public companies should be required by the IRS to publicly reconcile their publicly reported income and their tax reported income. Consideration should be given to a minimum tax of 10 percent of income as reported to shareholders. Other tax shelters such as carried interest, tax free like kind exchanges of real estate, and special treatment of option based executive compensation should scaled back or closed.
5. Eliminate special benefits for non-corporate business — instead of adding to them. Currently pass-throughs are taxed at a lower rate than corporations after accounting for dividend and capital gains taxes that are also paid on (some) corporate income. The administration plan regarding so-called pass-through entities has not been spelled out. Breaks for such entities run the risk of creating a major unjustified subsidy to law partners, merger advisers, management consultants and economic advisers. The right approach is the opposite. Businesses operating at large scale should be required to incorporate. This would increase revenue, fairness and for those who see a strong distinction remove a current subsidy to the paper pushing economy vis-à-vis the real economy.
I don't have a revenue scoring or distributional model at hand. My very rough guess would be that this approach to tax reform outlined here would enable a corporate rate in the high 20s, and would over the long-term enlarge the economy a bit, perhaps 2 percent, by increasing incentives for domestic production and making the allocation of capital more efficient. It would also increase the fairness and perceived legitimacy of our tax system and be a worthy follow on to the 1986 act. It would avoid the risk of a tax giveaway that hurts the economy by raising interest rates and magnifying the deficit. And, in a rational world, it could command bipartisan support and would modestly raise wage income as well as the overall size of the economy.
Commentary by Larry Summers, the former Treasury Secretary and currently the Charles W. Eliot University Professor and President Emeritus at Harvard University. Follow him on Twitter @ LHSummers.
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