In a surprising move Thursday, President Trump paved the road for Congress to get moving on tax reform. He did this by striking a deal with Democratic leaders to raise the federal debt ceiling, fund the government for the next three months, and provide money for Hurricane Harvey. White House Legislative Director, Marc Short, told reporters “I think it puts pressure on all of us to get tax reform done before December.”
TRUMP WANTS TAX CODE TO BE SIMPLE, FAIR AND EASY TO UNDERSTAND
Although we have seen no blueprint of the plan yet, President Trump told an audience in North Dakota he wants a tax code that is “simple, fair and easy to understand.” Reports indicate the proposal will include some reductions in corporate and personal rates and the end of some tax deductions. Nice to have, but these are considered tax cuts, not tax reform. For our leaders to attempt a fundamental reform of the tax code, they must first put aside their self-interests. They must stop looking at the tax code primarily as a method of transferring income to or from groups deemed in need, and cease using the handing out of deductions, exemptions, and subsidies to appease supporters. I do not know about you, but to me, that is a tall order, especially given the current state of dysfunction within the halls of Congress.
THREE MOST POPULAR TAX REFORM PROPOSALS
There are several options for tax reform floating around out there, each touting a result of ease for the tax payer and IRS and promoting dramatic economic growth. Most believe real change starts with switching to a consumption tax, which levies based on the purchase of goods and services rather than income, most commonly known as “national retail taxes” and “flat taxes.” The Tax Policy Center’s Briefing on understanding the federal tax system gives brief descriptions of the three most popular proposals:
Retail Sales Tax – A national retail sales tax would levy a flat tax on all retail sales. In most proposals, the tax would have a broad base, exempting only expenditures for education, existing housing, purchases abroad by US residents, and food produced and consumed on farms. Proponents argue that the tax would be simpler to administer and create fewer economic distortions than the income tax. However, in most forms, it would be regressive, disproportionately taxing low- and middle-income earners.
Value-Added Tax (VAT) – Value-added taxes are collected from businesses at each stage of the production process. Under the “credit-invoice method,” all sales by businesses are taxable, while firms claim credits for all taxes paid on purchases from other businesses. The result is that the tax base is equal to the full value of the final sale to the end user. The United States is the only developed country that does not have a value-added tax, which tends to have lower administrative and compliance costs than income taxes.
Flat Tax: A flat tax is a value-added tax divided into two parts. It was first proposed in 1983 by economists Robert Hall and Alvin Rabushka of Stanford University’s Hoover Institution. Their proposal called for a 19 percent tax at the business level on all value added other than wages. Households, for their part, would pay a 19 percent flat tax on all wages and pension benefits above a specified exemption level. The family exemption increases the progressivity of the tax. However, the tax structure is regressive relative to the current system as it lowers taxes for households at the high end of income distribution.
At present, VAT may be the most likely to succeed as it appears to be the safest in not raising taxes on the middle class, which was the main line drawn in the sand by Democrats in a letter sent to Republican leaders in early August.
Due to the complexity of the current tax code, it would be best if the reform is both swift and a complete uniform replacement. Adding layers or phases over time will cause more congestion to the already log-jammed process and end up costing more than it is worth. Tax reform is long overdue, and if done correctly, could have a tremendous positive impact for years to come. However, it will require rolling up the sleeves, working hard, and compromising political interest to do what is right for the American people. After all, that is what we should expect from the lawmakers we elect and put into public office.