4 ways the Senate could ruin good tax reform

By Adam Michel | The Daily Signal

The Senate version of the Tax Cuts and Jobs Act has successfully passed both the Finance and Budget committees and is now on the Senate floor.

As it currently stands, the Senate bill is a big improvement to America’s out-of-date tax code and could boost the economy by almost 3 percent.

There is a lot to like in the Senate bill. For example, it cuts taxes for individuals and businesses, repeals the state and local tax deduction, and allows businesses to invest more in the American economy through “expensing,” which benefits workers by providing higher wages and more jobs.

But, as the bill heads to the Senate floor, there are several worrying proposals being floated that would undermine the most pro-growth elements of the Senate plan.

1. Adding a Tax Hike Trigger

Holding pro-growth tax reform hostage over the near-term deficit impact is counterproductive and unwittingly undermines the very growth that tax reform promises.

Several senators have called for a trigger to be added to the tax bill that would increase the corporate tax rate if future economic growth or revenues fall below a projected level.

Lowering the corporate tax rate to 20 percent provides a substantial portion of the economic growth in the proposed tax reforms. Introducing the threat of reversing some of the tax cut in the future makes investment under the temporarily lower rate less appealing, especially for longer-lived assets.

Such uncertainly will slow investment and thus diminish tax reform’s expected growth.

In addition to slower growth, the benefits of temporary corporate tax cuts tend to accrue largely to investors, while permanent rate cuts largely benefit workers through higher wages.

There is no upside to adding in a tax trigger. The deficit cannot be eliminated with tax increases. Believing it can denies the fundamental problem: The deficit is driven by uncontrolled spending, not insufficient taxation. Spending is what Congress must work to control.

2. Raising the Corporate Tax Rate

The single most important component of the current tax reform bill is the 20 percent corporate income tax rate. Any proposal to raise that rate above 20 percent decreases the economic growth, jobs, and wage increases the American people have been promised.

Most worrying is a proposal from Sens. Marco Rubio, R-Fla., and Mike Lee, R-Utah, to increase the corporate tax rate to 22 percent to pay for an expansion of the refundable portion of the child tax credit. The Senate tax bill already includes a doubling of the child tax credit.

Raising the corporate tax rate to pay for an expanded child benefit would be counterproductive, as it would ultimately reduce the potential job opportunities and wage increase for working parents.

3. Reinstating the State and Local Tax Deduction

Tax reform should fully repeal the state and local tax deductions and use the savings to lower tax rates.

The Senate bill improves on the House bill by eliminating a retained $10,000 property tax write-off. The Senate should not put this subsidy for the wealthy and high-tax state governments back into the bill.

The state and local tax deductions are detrimental to the economy. They encourage higher state and local government taxes and shift those increased burdens from high-tax, high-income Americans to low-tax, low-income folks.

Reinstating a property tax deduction is costly and could thus undermine other aspects of the tax reform.

4. Expanding the Pass-Through Deduction

Congress should focus first on lowering the top marginal tax rate to 35 percent as originally proposed.

In response to concerns that small and pass-through businesses are not receiving a big enough tax cut, the Senate bill will likely expand the business deduction from 17.4 percent to 20 or 25 percent.

As explained in an earlier Daily Signal post, directly comparing business tax rates is misleading because traditional corporations face two layers of tax, distinct from the one layer faced by pass-through businesses.

Expanding the pass-through deduction to 25 percent will lower their total effective tax rate to 31.7 percent, while leaving the effective combined corporate rate at 39 percent. Tax reform should work to treat business income similarly rather than maintaining the current tax-favored status of pass-throughs.

Further expanding the business deduction also increases the incentives to re-characterize income from wage income to business income.

The House bill addressed this problem with anti-abuse rules that are arbitrary and unfair to certain types of businesses. The rules, however, limit the problem the Senate bill now faces by creating a system that is subjective and easily gamed by those with the right tax lawyers.

The Senate should not expand the business deduction, but should instead further lower the top marginal income rate below the current 38.5 percent rate.

Other Proposals That Could Improve or Detract From Tax Reform

There are other awful ideas being proposed, including raising the top marginal income tax rate back up to 39.6 percent, extending tax credits for coal, geothermal energy, and energy-efficient properties, and further taxing carried interest.

There are, however, ideas that could improve the bill. Kentucky Sen. Rand Paul’s proposal to fully repeal the Foreign Account Tax Compliance Act simplifies an unnecessary set of overly complex and burdensome regulations that have turned foreign banks into IRS enforcement agents.

Another amendment proposes to consolidate education savings accounts, which is a similar reform to the House’s proposal to make 529 college savings plans available for K-12 expenses.

The Senate should avoid watering down its pro-growth tax proposal and instead strive to improve the reform to maximize benefits for all Americans.

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