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Start Planning the Tax Reform of 2019

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Published : December 19th, 2017
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(This item originally appeared at on December 18, 2019.)

The target="_blank" Tax Cuts and Jobs Act of 2017, focusing on corporate taxes, is almost (if not quite) in the bag. Great! In the end, not much was done on the side of personal income taxes, even if that got a lot of attention. There is still much to do. I would get started in 2018, to pass something in 2019.

Where we want to go: A target="_blank" Flat Tax with a sub-20% rate. If you don’t know where you want to go, often you don’t get there. A sub-20% rate might still be too much of a leap in one go, although I am not sure about that. Sometimes it is easier to Go Big. Mostly, it depends on the power of peoples’ imagination. Some governments took the leap all at once (Russia, 13%), and had no problems at all. Others (Bulgaria, 10%) preferred at step-by-step approach. Tax revenue/GDP did not decline after these reforms. In the first year of Russia’s new Flat Tax system, nominal income tax revenues rose 47%.

After many years of discussion, I think it has become clear that a unified sales tax (“Fair Tax”) isn’t really going to work unless we repeal the Sixteenth Amendment – and also, reduce Federal spending by large amounts, to somewhere under 10% of GDP. However, I think there is a place for a target="_blank" unified sales tax at the State level. Maybe Texas should lead out here.

Bulgaria, one of dozens of governments that adopted a “Flat Tax” system, once had a top income tax rate of 50%.

A top personal income tax rate of no more than 25%. This would have been a radical idea this year, but I don’t think it will seem so strange in a year or two. If corporations are being taxed at 21%, and passthroughs are also getting advantageous rates, why should we be taxing individuals at 35%+? There is no reason, except for bad habit. This reduction in rates should be matched with widespread reduction in exemptions and deductions, such as was proposed this year. Basic deductions should rise somewhat, but you want to use your tax simplification “budget” mostly on lower rates. Much lower rates.

Elimination of capital gains, dividend and interest taxation. Corporate income is taxed at the corporate level, and should not be double-taxed after distribution. If interest is paid after tax (not expensed) at the corporate level, then interest income should not be taxed at the individual level either. Capital gains taxes are one of the most destructive taxes, not to mention one of the most complicated. The capital gains tax rate that maximizes revenue is 0% — the additional growth produces more revenue from other taxes. That is why many governments don’t tax capital gains at all, including Hong Kong, Singapore, New Zealand, Belgium, Germany, Malaysia, the Netherlands, South Korea, and Switzerland — not exactly a bad club to be a part of. Japan used to be among them, with no taxes on capital gains and interest income.

Eliminate expensing of interest. The elimination of expensing of interest at the corporate level was a reform partially accomplished this year, and should be completed. This eliminates an artificial advantage of debt capitalization over equity capitalization, which tends to make corporations unnaturally debt-heavy and thus bankruptcy-prone. This also opens the door to the elimination of expensing of interest at the personal level, especially mortgage interest. It might be nice to pair this with expensing of capital investment, as was part of the House tax bill.

Elimination of the Death Tax and Alternative Minimum Tax. Leftover housecleaning that should have been taken care of this time around. Widespread elimination of exemptions would make the AMT irrelevant in any case.

Simplification of Corporate Taxes. “Simplification” mostly means: the elimination of exemptions and deductions. Corporations got away this year with enjoying a much lower rate without having to give up much in the way of exemptions and deductions. On the personal side, the story was the opposite – many exemptions and deductions were threatened, while proposed reductions to rates were minor. Next time, it should be the other way around. This will probably create a revenue source that can help fund lower rates elsewhere. An additional reduction in the corporate income tax rate – perhaps to the 15% promised in Trump’s election campaign – might help smooth the way for large-scale elimination of exemptions. Eventually, we want what Britain has today – a corporate tax system that target="_blank" generates more revenue (as a percentage of GDP), at a lower rate. Britain’s 19% rate corresponds to a 15% Federal corporate tax rate, plus average State tax rates.

Ignore the Democrats’ whining. In the past, the Democratic Party was actually concerned with the wellbeing of the middle and less-than-middle classes, and this translated into an understanding that a healthy economy was the highest priority for these groups. Even if a rising tide doesn’t always lift all boats, it sure beats a sinking tide. That’s why target="_blank" Democrats cut taxes in 1964, proposed a large tax cut in 1975, joined with Republicans in the target="_blank" big bipartisan tax reforms of the 1980s (the target="_blank" Tax Reform Act of 1986, which produced a 28% top income tax rate, passed the Senate 97-3) and proposed a “middle class tax cut” in the 1992 presidential election (and won over the tax-hiking Republican George Bush). Eighty percent of House Democrats voted for the 1997 tax cuts. The Bush tax cuts in target="_blank" 2001 and target="_blank" 2003 were widely rejected by Democrats, but they would not have passed the Senate without the support of a few Democratic senators willing to break from Party consensus.

The Left-leaning social democracies of Europe (that Democrats claim to emulate) learned long ago the importance of a healthy economy, which is why they have been target="_blank" lowering corporate tax rates for two decades, and have light taxes on capital, in many cases with no capital gains taxes at all. But, apparently not one Democratic Congressman, in either the House or Senate, saw fit to support Republicans’ effort to copy this European model. They are lost in a fantasy world of gender and race politics. Forget about them.

Next up for Congressional Republicans is probably some action on spending, particularly welfare-related spending. This is a quid-pro-quo for deficit hawks, and is as it should be: tax cuts first, spending cuts afterwards. But, there is a lot of unfinished business on the tax side. Let’s get started on it.

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Nathan Lewis was formerly the chief international economist of a firm that provided investment research for institutions. He now works for an asset management company based in New York. Lewis has written for the Financial Times, Asian Wall Street Journal, Japan Times, Pravda, and other publications. He has appeared on financial television in the United States, Japan, and the Middle East.
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