Tax Reform at Ways and Means

April 15, 2016

A number of House Republicans have testified to the Ways and Means Committee about their ideas for overhauling the tax code. Rep. Roger Williams testified about his plan this week. And Reps. Michael Burgess, Devin Nunes, and Robert Woodall presented their plans a couple weeks ago.

Here are a few notes:

Michael Burgess Flat Tax. Rep. Burgess testified in favor of a classic Hall-Rabushka flat tax, which is the plan that has been supported by Steve Forbes and Dick Armey. The tax is named after economists Robert Hall and Alvin Rabushka, who is an adjunct scholar at Cato.

The Burgess plan would have a 19 percent rate (dropping to 17 percent), a large standard deduction ($32,000 for a married couple), and large child deductions ($7,000 per child). My preference would be for a lower rate with a smaller standard deduction, but the Burgess plan is generally excellent.

The flat tax would vastly simplify the tax code. Individuals would be able to file their tax return on a postcard because the plan would abolish nearly all deductions, exemptions, and credits, and individuals would be generally only taxed on their labor income. All capital income would be taxed at the business level at the same 19 or 17 percent rate.

Business taxation would have a simplified cash-flow structure, and companies would immediately write-off capital investment. Complex income tax concepts such as depreciation, amortization, and capital gains would be abolished.

The Burgess tax would eliminate the current tax code bias against savings and investment, which is a key weakness of income taxation. With an economically neutral base and a low rate, the Burgess flat tax would be very pro-growth.

Devin Nunes Business Tax. The Nunes proposal is essentially the business part of the Hall-Rabushka flat tax, but with a 25 percent rate. This is a cash-flow tax, meaning that accrual accounting and noncash concepts such as depreciation would be scrapped. Business investment would be expensed.

Rep. Nunes may have been inspired to pursue his proposal by my 2003 Cato study on replacing the corporate income tax with a business cash-flow tax. Alan Viard at AEI has also written about the idea.

Politicians love to rail against corporate tax avoidance. But the way to actually solve the problem would be to slash the tax rate and replace the current business tax base—which relies on the imprecise concept of “income”—with the easy-to-measure base of net cash-flow, as under the Nunes plan. The current system has so many “loopholes” partly because Congress is taxing the wrong base.

The Nunes plan would be territorial, meaning that the earnings of foreign subsidiaries would not be taxed by both foreign governments and the U.S. government. The plan would encourage multinational corporations to locate their headquarters and their factories here in America, and that would be a boon to U.S. workers. 

Robert Woodall FairTax. Rep. Robert Woodall proposes replacing federal income and payroll taxes with a national retail sales tax called the FairTax. I appreciate the radical spirit of this proposal, and if it were enacted, it would simplify taxation and boost economic growth. However, there are risks to this sort of reform.

One risk is that Congress enacts a national retail sales tax and the income tax is either not repealed or it comes back down the road. The last thing we need is for the overgrown government to have multiple huge tax bases. The Woodall bill would repeal the 16th Amendment, but I don’t think that would be sufficient protection to prevent resumption of income taxation. After all, Congress enacted the corporate income before the 16th Amendment was adopted by claiming that it was an “excise” tax, and today this “excise” tax is the most damaging part of the income tax. Presumably, a liberal Congress could decide that it wanted to impose a similar “excise” tax on America’s more than 20 million small businesses.

Another concern about the FairTax is the plan’s rebate mechanism that would provide families a check each month to offset part of the sales tax burden. That would be a large and redistributive entitlement program, and it would surely become larger and more complex over time as politicians expanded and manipulated it.

All that said, kudos to the sponsors and cosponsors of these bills for their support of a dramatic tax overhaul. Let’s hope that their support can be translated into major tax reform moving through Congress next year.  

For more on the flat tax, national sales tax, and other reforms, see here.

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