It's time for pro-growth tax reform
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It is troubling that the U.S. economy has grown at only a 2 percent rate during the course of the recovery from the Great Recession. It is even more troubling that the latest Congressional Budget Office projections indicate that the future will hold slower, not faster, growth.

This poor macroeconomic environment has translated into poor wage growth—inflation-adjusted average hourly earnings have crawled along at an average annual growth rate of 0.25 percent during the recovery—and diminished labor market incentives. The labor force participation rate remains stuck below 63 percent and shows no sign of recovering to historic norms.

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Meanwhile, U.S. corporations investment outlays have grown at a muted pace during the recovery, and many corporations are fleeing the United States entirely through so-called “tax inversions.” These started out as situations in which a U.S. company would literally swap the roles of the U.S. headquarters and the foreign subsidiary. By “inverting,” the company would attempt to be subject to the tax rules of the country in which the new headquarters was located. Tax changes in the early 2000s put an end to the plain vanilla tax inversion.

 

More recently, as U.S. firms purchased or merged with foreign corporations, it quickly became obvious that it would be advantageous for the headquarters to be located abroad. Why? To begin, the U.S. corporation tax rate is 35 percent—well above the 15 to 20 percent range that is competitive with other developed countries.

Worse, that rate applies to income earned anywhere in the world, whereas competitors headquartered elsewhere would be liable for tax only on what was earned in each country. A second wave of inversions ensued as ordinary business deals ran into the unavoidable tax facts: the United States is an uncompetitive place to be headquartered.

Ultimately, it was recognized that it did not matter who started the transaction. It could just as well be a foreign firm purchasing or merging with a U.S. firm. In either event, it made sense for the headquarters to be abroad. Whether as predator or as prey, U.S. companies have no choice but to locate headquarters abroad in the midst of these transactions.

Tax reform is an opportunity to address the growth problem. It’s an opportunity to restore work, rising wages, and incomes to the middle class. It will keep America’s companies in its borders and attract foreign investment into the United States.

There is a strong body of research indicating that a high corporate tax rate suppresses investment, productivity, and economic growth. Among the more telling examples is a study by the Organisation for Economic Cooperation and Development (OECD) that notes, “Corporate income taxes have the most negative effect on GDP per capita.” Lowering the rate would have a significant and positive effect on economic growth, and therefore on employment and wage growth.

U.S. corporate tax reform is essential, but any effort to attempt to reform “business” taxation that focuses solely on the corporate code would miss the incentives for businesses taxed through the personal income tax. The past several decades have seen the relative growth of these “pass through” entities compared to traditional C-corporations. Individual income tax reform has to be in the mix. This would be a welcome relief for the individuals faced with a tax code is riddled with inefficiency and complexity that hobbles taxpayers, diminishes work incentives, and harms the economy as a whole.

The need for, and benefits of, a comprehensive pro-growth tax reform should be self-evident. At present, however, there is a single such proposal on the table in Washington: A Better Way, the blueprint unveiled by the House Republicans.

Unfortunately, the only feature of the blueprint that seems to be widely recognized is its proposal to “border adjust” the U.S. tax so that all goods compete on a level tax playing field in both the U.S. and export markets. This proposal has generated controversy that has distracted from the fact that the blueprint is a comprehensive, pro-growth reform that promises improved productivity growth, more rapidly rising real wages, investment in tangible and intangible assets, less tax interference in capital allocation, and improved economic growth.

Its features include lower rates on corporations at 20 percent, pass-throughs at 25 percent, and all individuals with a maximum rate of 33 percent. It features strong saving—through a 50-percent exclusion from tax of interest, dividends, and capital gains—and investment incentives of immediate expensing or deduction of capital outlays. It also features neutral treatment of debt and equity that gets the government out of the business of dictating financial structures. It retains a strong research and development incentive.

The time is ripe for pro-growth tax reform in the United States. The House blueprint is a perfect start for the reform process.

Douglas Holtz-Eakin is president of the American Action Forum. He served as director of the Congressional Budget Office during the George W. Bush administration from 2003 to 2005. He later served as chief economic policy advisor to U.S. Senator John McCainJohn McCainEx-Bush aide Nicolle Wallace to host MSNBC show Meghan McCain: Obama 'a dirty capitalist like the rest of us' Top commander: Don't bet on China reining in North Korea MORE's 2008 presidential campaign.


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