Paul Ryan’s Tax Reform Proposal

Late last month, Speaker of the House Paul Ryan released the tax reform component of his “A Better Way” task force project undertaken in collaboration with GOP House members.   It deserves serious attention.

The real importance of this proposal is the structural change it contemplates:  specifically, moving the tax system more toward a consumption base and changing the reach of the corporate tax.

Here are the key points: 

  • Moving toward a business cash flow tax  The proposal calls for an immediate write-off (expensing) of business investment combined with an elimination of deductions for net interest (special rules on interest deduction for financial services). 

 

  • Territorial and Border Adjustability  The task force calls for a “destination-basis” corporate tax system, meaning the reach of the corporate tax would be territorial and exports would not be taxed while imports would be subject to taxation.  Current World Trade Organization rules allow border adjustability for Value Added Taxes but not for corporate income taxes.  Speaker Ryan and his colleagues believe that moving toward a cash-flow method for taxing business income would make border adjustability possible under WTO rules.

 

  • Repatriation Holiday  Existing  earnings accumulated overseas would be repatriated subject to a low tax rate payable over eight years.

 

  • Treatment of Pass-Throughs  For C corporations the top rate under the reform regime would be 20%.  To solve the inevitable problem of the tax treatment of S corporations, partnerships, etc., the task force would distinguish between “reasonable compensation to owner-operators” which would be deductible by the business and payable by the recipient and active business income which would be taxed at 25 percent at the individual level. level.  Obviously this would require careful rulemaking.

 

There is much more to the task force proposal including suggested reform of the IRS, the development of a simplified “postcard” tax form for individuals with a large standard deduction (or, alternatively use of the mortgage interest and charitable deductions), elimination of the individual AMT, and repeal of the estate and generation-skipping transfer taxes.

Just as Kemp-Roth and similar tax proposals provided the intellectual framework for the tax reform of 1986 without fully anticipating the details, Ryan’s recommendations should set the boundaries for future tax reform, perhaps as early as next year.   Compared to what we have heard from the two Presidential candidates, the task force’s ideas have the added advantage of being serious.  It would be great if House Democrats would attempt a similar contribution to the policy mix on many of the same topics.

 

Shortening the Ten-Day Filing Window

In 2011, ABC submitted this comment letter to the Securities and Exchange Commission (SEC) in support of a petition for rulemaking by the law firm Wachtel, Lipton, Rosen & Katz.  Wachtel’s petition called for shortening the ten-day filing window under SEC rules between the time a shareholder or group of shareholders amasses a five percent position in a publicly-traded company and when it must report that fact to the Commission.

The ten-day period, as noted in our letter, is an anachronism that has been exploited by hedge funds and other large activist investors to trade on material, inside information.  ABC argued for immediate disclosure of a five percent position.

The SEC never took action on this matter and the Wachtel petition languished.

Now, interestingly enough, a group of liberal Democratic Senators, including Bernie Sanders, has introduced legislation that would, among other things, shorten the ten day period to two.  The bill is called the Brokaw Act (S. 2720).  It is named for a town in Wisconsin that saw its paper mill closed due to hedge fund maneuvering, according to the bill’s chief sponsor, Senator Tammy Baldwin of Wisconsin.  Other sponsors of the Baldwin Act are Jeff Merkley (D, OR) and Elizabeth Warren (D, MA).

Hedge funds are important players in the capital markets and corporate takeovers can lead to great economic efficiencies.  But the ten-day window between the time a five percent position in a publicly traded company is acquired and the disclosure of that fact cannot be justified in a period  of rapid information dispersal.  The window should be narrowed, if not closed, ideally by the Commission or, if not, via the Brokaw Act.

 

Hope for Tax Reform?

The Presidential campaign season thus far has not been remarkable for sparking intelligent public policy discussions.  And that does not bode well for how our nation’s economic problems will be addressed after the election.  Trade policy seems to be in the deep freeze.  Immigration reform has been infantilized.  And the most dangerous issue of all:  our large and rising national indebtedness, has been all but ignored or, worse, wished away with bizarre proposals about expanding entitlement programs whose effect, if adopted, would make the situation worse.

Is tax reform any different?  Perhaps not.  But there may be reason for very qualified optimism that something might be done next year.

For one thing, all of the Presidential candidates have reasonably detailed tax reform proposals that, if nothing else, would seem to signify a desire for reform.  Simultaneously, the two tax writing committees of Congress, the House Ways and Means Committee and the Senate Finance Committee are working on ideas that the next President could adopt, partially or in full, in an effort to achieve a bipartisan reform bill.

As for the American Business Conference, we continue to press for comprehensive tax reform.  Comprehensive instead of business because companies are organized for tax purposes in different ways.  That means changing the corporate tax alone will not help all firms.  To do the job right, we must change for the better the individual as well as the corporate tax.  It’s a tougher lift, to be sure, but it is the way to go.

Recently, ABC has associated itself with a coalition calling itself Parity for Main Street Employers.  This letter, sent to senior members of Ways and Means and Senate Finance, outlines the tax ideas of the group.  As ABC has done for some time now, the letter calls for integrating the corporate tax so as to eliminate the double taxation of corporate profits.  Second, it calls for a restoration of rate parity between pass through businesses and C corporations.  The end result would be an equitable, pro-growth taxation of all businesses instead of the uncompetitive mess we now endure.

The only thing that is missing from the letter, in our view, is that it does not mention reform of the way the nation taxes foreign profits.  On that point, ABC continues to press, in other fora, for adoption of a territorial system.

Fast Track and the Declining Consensus About Growth

After much effort, Congress has passed and President Obama has signed Trade Promotion Authority legislation, better, if inaccurately, known as “fast-track.”  In a nutshell, fast-track is a legislative device to allow Congress to consider and vote on trade agreements without amending the deal after the fact.  Over the last few months, American Business Conference executives have been arguing in favor of this legislation and are of course pleased that it ultimately was adopted.  Since at least the days of the Canadian-US Free Trade Agreement during the Reagan years, ABC has strongly advocated fast-track as the means to capture the growth and job-creating possibilities inherent in international trade and investment agreements.

What made this battle different from previous ones is the nature of the opposition.  Of course the usual suspects, organized labor, religious groups, environmentalists, public interest coalitions, and one-world, anti-growth hipsters led the charge against fast-track.

What was new was the presence of conservative Republicans in opposition.

That many of the Republican members of Congress could be against fast-track illustrates, at least in part, the low level of confidence even some Republicans now have in American business.  Put simply, they, along with their unlikely union allies, do not believe that more open international trade and investment will yield growth benefits that will ultimately accrue to the American people.  The notion that the economy and government are scams that reward only C-Suite types is an intellectual drag on the economy that affects all business and workers.

The possibility and even the desirability of economic growth are no longer taken for granted.  For this reason, fast-track just barely squeaked through Congress.    In short, the crisis in trade policy is really the crisis in growth policy.

We are in the midst of history’s slowest recovery from recession, with first-quarter gross domestic product limping along at an annualized rate of 0.2 percent.  To the extent that Washington can do anything about this, it hasn’t.  Tax reform is dead in the water, the entitlement-driven debt overhang, as the CBO recently pointed out, is worsening, infrastructure improvements are languishing, and the regulatory burden of such things as Dodd-Frank continues.  Without the unifying concept of growth and what it can do for society these problems will persist.

 

 

Governor Christie and Entitlements

When a political leader takes a tough position on a politically difficult issue affecting our future standard of living, he deserves credit.  Case in point:  Governor Chris Christie’s speech last Tuesday at the New Hampshire Institute of Politics.  His subject was entitlement reform.

The Governor argues what is demonstrably clear:  the Social Security System and Medicare are not affordable over the long term as they are currently constituted.  He is calling for change, although that change would not affect “seniors currently in these programs or seniors approaching retirement.”  In essence, then, he would take the Boomers out of the discussion.

For Social Security, Christie proposes the following:

  • he would gradually raise the retirement age, beginning in 2022 to 69;
  • he would at the same time eliminate the payroll tax for “working seniors”; and,
  • he would introduce “means-testing” affecting those with non-Social Security income of over $80,000 per years and phase out Social Security payments entirely for those that have $200,000 a year in other income.

Christie would introduce similar changes in Medicare as well as reforms to the much abused disability insurance system.

Liberal Democrats, such as the late Senator Edward Kennedy, opposed even modest mean-testing (as did FDR) because their view was that the system could not be sustained unless all Americans received Social Security benefits.  This is why nowadays they would increase Social Security payments for everyone while raising the lid on the amount of taxable income subject to FICA.

Christie implicitly counters this strategy when he appeals to the charitable instincts of the wealthy:  “if you are fortunate enough not to need [benefits], you will have paid into a system that will continue to help Americans who need it most.  That is what we have always done for each other through private charity and good government.”

People are referring to Christie’s speech with the usual nonsense about it being the spark for a “national conversation” about entitlements.  Given the reluctance of politicians to talk about the issue, Christie’s spark will likely fall on wet kindling unless voters insist otherwise.

 

A Dangerous Change in Cost/Benefit Analysis

The Brookings Institution has just published a working
paper of real importance on a profound change in cost/benefit analysis.  Don’t be fooled by its innocuous, academic title:  “Determining the Proper Scope of Climate
Change Benefits.”  It is worth your attention.

While its authors, Ted Gayer and Kip Viscusi, believe that human-generated climate change is real, they are asking serious questions about the Obama Administration’s calculation of the benefits of the EPA’s recent proposed rule on power plant emissions.

In a nutshell, Gayer and Viscusi find that the Administration defines the cost of the power plant proposed rule domestically while defining the benefits in global terms.  “This practice,” they write, “is not only inconsistent with what we consider to be the proper scope of benefit assessment, but is also inconsistent” with existing OMB guidance.

Here’s the bottom line:  the EPA estimates the benefits of its proposed power plant rule to be $30 billion in 2020 using a 3 percent discount rate.  However, only 7 to 23 percent of those benefits would be domestic, based on the Administration’s own methodology.  “As a result,” Gayer and Viscusi write, “the domestic benefits amount is only $2.1 billion – $6.9 billion, which is less than the estimate compliance costs for the rule of $7.3 billion.”

No other country employs this asymmetrical approach to cost/benefit analysis.  It is entirely the product of the Obama Administration.  As the authors note, if such an approach “applied broadly to all policies,” it would “substantially shift the allocation of society resources.”  For example, “the global perspective would likely shift immigration policy to one of entirely open borders,” shift away from “transfers to low-income U.S. citizens towards transfers to much lower-income non-U.S. citizens,” and “drastically” change defense policy.

Indeed, such a methodology could profoundly change all administrative rulemaking, including  such business-related agencies as the SEC.  The prospect of altering commonly held views of the scope of cost/benefit analysis should not be accepted without careful debate because cost/benefit analysis is at the heart of measuring the growth effects of regulation.

Scrap the Corporate Income Tax

Corporate tax reform is an evergreen issue in Washington.  Most recently, House Ways and Means Committee Chairman Dave Camp has produced a reform proposal that has justly been praised by the tax expert Martin Sullivan as “monumentally important” for its seriousness and workmanship.  It is also, as Sullivan, among others, admits, not likely to be enacted anytime soon.

Rather than try to reform the beast, isn’t it time to think about getting rid of the corporate income tax with all of its complexity, enormous compliance costs, and perverse loopholes put in place by business lobbyists who regard tinkering with the tax as their own perpetual ATM machine?  Intelligent observers have suggested as much.  For example:

 

 

  • Lefty writer Matthew Yglesias, for his part, has given up on the possibility of corporate tax reform and advocates something “bigger and tougher:” abolition.

 

  • Economist Laurence Kotlikoff of Boston University believes that the there is a “worker based,” pro-jobs case for eliminating the corporate income tax, particularly for “young and future workers.”

 

  • Another commentator, Mark Levey, writing at the beginning of President Obama’s first term, somewhat optimistically hoped the new President would press for cutting the corporate tax rate to 0% as the “quickest way” to bolster the credit markets and “get money into the economy for true job creation.”

 

If getting rid of the corporate income tax seems hopeless, consider that in some ways it is already happening.  As ABC Chairman Al West testified before the Center for Strategic and International Studies’ Strengthening of America Commission two years ago, there has been an “explosion” of firms organizing themselves as Subchapter S corporations or as partnerships.

These “pass-through” entities avoid the corporate tax entirely and their growth in number therefore erodes the corporate tax base.  Nor are they all small businesses.  More than 14,000 Subchapter S corporations have revenues of more than $50 million.  We are thus, West noted, “in the position of having businesses of similar size selling similar products and services, yet facing different tax obligations based solely on the way they are organized.”

Ignoring, for a moment, the political difficulties, how would one eliminate the corporate tax while insuring that the wealthy do not subsequently use corporations as tax shelters?

One possible approach draws on Canada’s Gordon Commission from back in the 1960s.  It involves what might be called an extreme integration of the corporate and personal taxes. Each year shareholders would get a report (like a 1099) that would say, in effect, “we paid you X in dividends and paid Z in corporate taxes on that portion of profits. Add X+Z to your taxable income and take Z as a tax credit. We also reinvested A in the corporation and paid B corporate tax on that part of profits. Add A+B to your taxable income and take a tax credit of B.   Also raise your cost basis in the stock by A for the purpose of capital gains taxes.”

That approach effectively does away with the corporate tax. However, there are complications. How do you deal with sales of stock during the year? How do you deal with different classes of shares – preferred, voting, nonvoting, etc.?  The first problem could be dealt with using year-end records. Presumably the market would recognize that stocks purchased during the year came carrying a tax credit. The latter problem could be dealt with arbitrarily.

This proposal was deemed far too radical for conservative Canadians.  But it has a certain intellectual purity. The equivalent of a 1099 for shareholders would not be that complicated. As for keeping track of adjustments in cost basis for stock held for a long time, presumably this would be done through brokerage accounts (the vast majority of shareholders own stock through brokerage accounts).

Another approach could be drawn from the world of non-profits.  Foundations pay a tax based on failure to payout a percentage of principal every year. There are clear formulas and all foundations try to avoid paying taxes by meeting the disbursement requirements, which is the objective of the tax after all.

The same concept could be applied to corporations and undistributed profits. It could be based on a percentage of profits which would be easy to do as GAAP are clear and disbursements would be easily audited. The percentage to be paid out could begin by simply adopting the existing tax rate structure. It could be changed annually by reviewing tax revenues generated.

Actually most individual taxpayers that would receive these dividends would be in a higher tax bracket than the corporations and if the government so chose it could make this class of distributions taxed at a higher rate than ordinary income, capital gains or dividends. There could be thresholds of exemptions and accelerating rates based on levels of income.  “This,” one ABC member has written,” could be a no-brainer benefiting corporations and giving the government the opportunity to generate even more tax revenue. The money that corporations would save by not having to file tax returns would be substantial as would domestic business expansions and job creation.”

Of course if neither of these ideas, or anything similar, is likely to be put on the political table, if only for discussion.  That’s because, on tax policy, the power centers in Washington, while ostensibly in intellectual opposition to one another, almost always converge to enshrine the status quo, which is what they know best.  The problem is, in the current competitive world, the status quo is a recipe for decline.

 

 

 

 

 

President Obama Abandons Chain-Weighted CPI

President Obama’s FY 2015 budget will not include a proposal to adopt a so-called chain-weighted Consumer Price Index (CPI).  The chain-weighted provision, one way to measure inflation, would have moderated the growth in cost-of-living adjustments (COLAs) for some entitlement programs such as Social Security and slowed the adjustment of tax brackets, which are also indexed to inflation.  Put simply, adoption of the chain-weighted measure of inflation would have simultaneously lowered the cost of entitlement programs while raising new revenues.

The combination of less spending on entitlements and more revenues would amount to savings of around $400 million over ten years.  That’s not enough to address our long term fiscal problems but it’s a start – one that some thought would enjoy bipartisan support.  The chain-weighted provision also has the added advantage of being, according to many economic analysts, a fairer gauge of inflation and consumer response to higher prices.  This paper, from the Moment of Truth Project, makes the case for the superiority of the chain-weighted measure.

The President had included a chain-weighted provision in his FY 2014 budget.  The question is, why did he drop it this year?  Some liberal Democratic Senators have made it clear they oppose the chain-weighted CPI, opting instead for an inflation measure that would increase cost-of-living adjustments.  Their argument is not based on economic accuracy; they simply want to expand entitlement payouts.

Moreover, Congress just recently repealed, and on a bipartisan basis, a COLA adjustment for military retirees – a provision that it had overwhelmingly passed shortly before as part of the 2013 budget compromise.  One can argue that this volte-face was primarily driven by a desire not to single out veterans.  Nevertheless, Congress’s action demonstrated for all who care to see that any kind of COLA adjustment that reduces entitlement spending, however economically justified, is a tough sell – one that Republicans and Democrats have little stomach for undertaking.

Demographers have famously compared the life stages of the Baby Boom generation to a swallowed pig making its way through a python.  Now as the Boomers move to and past retirement age, they may be too far through the snake to accept arguments for moderating the growth of retirement programs.  Could the President’s decision to drop his chain-weighted CPI proposal be an early sign that the nation – or at least older Americans who reliably vote – simply don’t care about America’s future?

A Note on Raising the Minimum Wage

The Congressional Budget Office’s (CBO) recent report on the effects of a minimum-wage increase on employment and income has earned a lot of attention, mostly because  Democrats seem to be planning a vote on legislation to raise the minimum wage.

President Obama has already, through executive order, raised the $7.25 minimum wage federal contractors must pay workers to $10.10 per hour (beginning January 1, 2015 on new contracts).  The President’s executive order was of course meant to be a precedent for a broader bill.

Raising the minimum wage serves the Democratic agenda in two ways.  First, it is designed to mitigate objections that their immigration reform program will harm low-wage workers by flooding the labor market.  Second, it fits nicely into the President’s attack on what he sees as the mal-distribution of wealth.  Senate Majority Leader Harry Reid, has made this point on his Twitter account:  ”The Koch bros made over $18 billion last year, but middle-class families have watched their incomes stagnate for decades. #Raise the Wage”

However satisfactory it would be to pick the Koch brothers’ pockets, it isn’t clear that raising the minimum wage will get the job done.  Consider this paragraph from the CBO report:

“Increasing the minimum wage would have two principal effects on low-wage workers.  Most of them would receive higher pay that would increase their family’s income, and some of those families would see their income rise above the federal poverty threshold.  But some jobs for low-wage workers would probably be eliminated, the income of most workers who became jobless would fall substantially, and the share of low-wage workers who were employed would probably fall slightly.”

In other words, it looks like one of the economic effects of the minimum wage would be in the form of a transfer payment from some poor workers to other poor workers.  That many more workers might benefit compared to those thrown out of work is not a compelling argument for those in the latter category.

How many workers would lose their jobs if the minimum wage is raised?  If the wage were raised to $10.10, CBO’s “central estimate” for the second half of 2016 is a loss of 500,000 jobs.  By contrast, raising the minimum wage to $9.00 yields a “central estimate” of 100,000 jobs for the same time period. The White House argues that the CBO’s estimate for job losses is wildly inflated.  In fairness to CBO, it presented a range of possible employment impacts with, as noted, the 500,000 and 100,000 numbers characterized as “central estimates.”  So, yes, job loss could be less; it could also be much higher, too.

The number of workers potentially affected by a minimum wage increase is considerable.  According to an interesting study from Brookings, only 2.6 percent of workers are paid the minimum wage, “but 29.4 percent of workers are paid wages that are below or equal to 150 percent of the minimum wage in their state” (some states have minimum wages higher than the federal minimum wage). These latter workers, if history holds true, would also see increased hourly compensation as part of a ripple effect.

The Brookings scholars conclude that “35 million workers from across the country could see their wages rise if the minimum wage were increased.” To their credit, the authors of the Brookings study “hasten to note that a complete analysis of the net effects of a minimum wage increase would also have to account for potential negative employment effects.”  Their piece does not provide this “complete analysis.”

The attraction of raising the minimum wage as a kind of magic bullet to help low-wage workers is undeniable.  And its political attractiveness has been made all the greater by the failure of opponents to make the case for pro-growth, pro-job policies.  The exhaustion of faith in our economy and in the efficacy, or even possibility of economic growth through private sector expansion, is the best friend that proponents of an increase in the minimum wage could hope for.

As ever, when the pie doesn’t grow, the temptation to reslice is hard to resist.