By Matt McDonald, BUILD Treasurer and Partner at Hamilton Place Strategies
Tax reform has the capability to give a big boost to businesses and the rest of the economy. The tax code has had 15,000 new rules since the last tax reform in 1986 and is complicated and outdated for the current economy. However, that does not mean reform is guaranteed to be a success.
There are two views of tax reform in Washington.
- We need to lower rates and broaden the base, as the U.S. statutory tax rate on corporate profits is the highest in the world. Reform should work to lower rates. Low rates with a broad base are a goal for many reformers as it’s more efficient and encourages growth.
- We need to simplify and clean a tax code that is too complicated and full of clutter and special favors. By cleaning the tax code of these provisions, we can finance lower rates, simplify the code for small businesses, and stop spending as many resources as we currently do on just paying taxes.
Both views pose some risks for pro-growth reform.
- Fetishizing rates creates the potential for harmful policies to pass just to lower rates.To lower rates, we need “pay fors,” as reform that reduces revenue is politically impossible in the current environments. The question is: does the “pay for” distort the economy more than the original code?As an example, an issue that I am working on is interest deductibility for businesses. Businesses’ interest on debt has always been considered a cost of doing business and has thus been fully deductible for over 100 years. This makes sense because credit is fundamental to business. You use it to finance expansion or to smooth cash flow and make payroll. However, policymakers are considering limiting interest deductibility as it can help pay for the goal of rate reduction. According to EY (Limiting corporate interest deductibility reduces long-run growth — New EY Study), the policy would reduce long-run growth by $33.6 billion in today’s economy. This is an example where reform could actually make things worse not better, and a reminder of the unintended consequences that are always around the corner in DC.
- With attempts to reduce “loopholes,” politically helpful carve-outs for small business or a particular industry can make the code more complicated, not less. If a policymaker wants to eliminate one tax incentive, but then grants carve-outs to multiple groups, we go from one special tax policy to multiple special tax policies. This adds complexity but can alter incentives as well. We could end up with a tax code with many cliffs as certain provisions still apply to firms with less than 50 employees or firms with x amount of employees working 30+ hours. (See the anecdotal examples of firms trying to game health care reform by shifting workers to part time status.) These cliffs will distort incentives and could make the code even more complicated.
Rather than focusing too much on rates or simplification, the goal above all else in tax reform must be economic growth. Other goals are merely means to higher economic growth, but, as shown above, can lead to tax policy that reduces, not increases economic growth.