5 must-haves for tax reform
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The next two years present the best opportunity for comprehensive tax reform in 30 years. This is important because tax reform can have a large effect on economic growth.

But despite Republican control of Congress and the White House, success is not guaranteed. Tax reform involves dozens of complex, highly contentious issues, all of which are very important to someone. Without focused leadership, the process can easily become stalemated over any one of a number of issues, many of which have little impact on economic growth.

To avoid this fate, Congress and the president should try to reach agreement on the most important elements of tax reform as quickly as possible. The Information Technology and Innovation Foundation (ITIF) believes five "must-have" elements are crucial for a successful bill.

Any legislation that contains all five of these elements deserves support, regardless of how other, secondary, issues are resolved.

1. A dramatically lower corporate tax rate.

The current federal rate of 35 percent is the highest among developed countries. This discourages domestic investment from both domestic and foreign firms. The burden is actually greater because, unlike most countries, the United States also imposes substantial taxes at the state and local level (averaging roughly 4 percent).

America must respond to the fact that other countries have been lowering their statutory and effective corporate tax rates over the last 30 years. Serious proposals have been put forward that would reduce the statutory rate to 15 to 20 percent.

2. A fix for the taxation of foreign profits.

Unlike most countries, the United States taxes foreign profits. This places U.S. companies at a disadvantage in foreign markets.

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To reduce this burden, the tax is deferred until companies bring their profits back to the United States. The result is that roughly $2.5 trillion in overseas profits are currently held offshore. Without the tax penalty, much of that would be brought back and paid to shareholders or invested.

 

Regardless of what the final corporate rate is, if the tax rate on foreign income was lowered to 15 percent, much of the offshore profits would return home, in part because companies can deduct the taxes they pay to foreign governments.

Deferral of the tax liability would also not be necessary. Not only would U.S. companies no longer face a higher tax rate than their competitors, the incentive to transfer profits abroad would also fall.

3. Stronger incentives for research and development.

Economists have long shown that, because companies cannot capture all of the benefits from their own research and development (R&D), it makes sense to provide some kind of subsidy. The R&D tax credit is a simple way to do that without favoring any particular technology or industry.

The current research and experimentation tax credit has broad bipartisan support. The Obama administration estimated that every tax dollar lost to the credit generated an additional $2 in research and increased economic welfare by up to $3. Given that at least 26 other nations have more generous tax incentives for firms to spend money on R&D, Congress should increase the rate of the simplified version of the credit from 14 percent to 20 percent.

4. An innovation box taxing the profits from sales of innovation-based goods and services at a much lower rate.

This is especially important if the statutory rate remains above 20 percent. Intellectual property is increasingly mobile, allowing companies to move it to low-tax countries. An innovation box would give firms a reward for commercializing new technology and encourage them to declare the profits here.

To maximize its effect, the proportion of profits that qualify for a lower rate should be linked to the research and production actually done in the United States.

5. The ability to deduct investment in plant and equipment from taxable income.

Investment makes workers more productive, justifying higher incomes. Current provisions allow companies to immediately deduct up to $500,000 in capital expenses, although this benefit phases out once investment exceeds $2 million. Companies can also deduct 50 percent of qualifying expenses.

Tax reform should make these provisions permanent and should remove the phase-out for deducting the first half-million.

ITIF believes there is broad consensus on each of these provisions. Passage of a bill containing all of them would benefit almost all companies either directly or indirectly while boosting economic growth.

The danger is that prolonged disputes over issues such as border adjustability, budget neutrality, lower rates for individuals, so-called pass-through businesses and a host of other issues could derail the bill. It is easy to underestimate the difficulty of gathering support for a good bill. Industries often have a tendency to focus mainly on those aspects of reform that benefit them the most rather than on the broader good.

Many voters seem to have lost faith in the political process. They wonder whether the federal government still possesses the ability to address the problems that are relevant to them.

One of the most important problems is to recreate the conditions for rapid economic growth that benefits the country as a whole. Comprehensive corporate tax reform is one of the most promising steps Congress can take in this direction.

It would be shame if disagreement about the best eclipsed a consensus around the good.

Joe Kennedy (@JV_Kennedy) is a senior fellow at the Information Technology and Innovation Foundation, a science- and tech-policy think tank. Kennedy was formerly the chief economist at the U.S. Department of Commerce.


The views of contributors are their own and not the views of The Hill.