Republicans try but fail to reach Reagan ideal of true tax reform

Republicans try but fail to reach Reagan ideal of true tax reform
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True tax reform is not just rate reductions and patchy simplifications. Tax reform, as it should be, is an overhaul of the very structure of the income tax system that has evolved into an albatross around the neck of the economy. It causes insurmountable budget dilemmas and political controversies. However, tax reform is doomed to be influenced by the Congressional Budget Office and the Washington think tanks that really control the process. This is simply a numbers game that, unfortunately, not many of us in America really understand, least of all the U.S. lawmakers who ultimately will vote on it. Tax reform, as it is now being conducted, is a band aid on the economic issues on the horizon, including the national debt, Social Security, welfare, health care, infrastructure and defense. This is not real reform, just a stopgap.

Discussion of true tax reform that we desperately need should begin with the acknowledgement that the income tax is arcane and must be phased out. The common wisdom is that a modern taxation system that does not have its base in income must replace it, that the tax system must generate enough revenue for the well-being of all Americans and that all Americans shall contribute to it. Instead, Congress continues to address tax reform as it has in the past, as “simplification,” defined as reducing rates and closing loopholes.

If Congress wants to enact the one substantive tax reform that could really impact Americans while not scrapping the ominous income tax, it should reach back a generation and tear a page out of the Reaganomics playbook. President Reagan realized that investment, and real estate investment in particular, was a valuable key to personal economic growth. It proffered opportunity in real estate investments primarily by reforming depreciation deductions. This expansion of depreciation deductions and the ability to deduct investment interest gave rise to what politicians called abusive tax shelters, and the Tax Reform Act of 1986 effectively barred these shelters.

In the 1980s, there was an outcry for tax reform after the bull market that began in 1982. Reagan’s military buildup ratcheted up the deficit, and these revenue shortfalls concerned Congress. Although the Tax Reform Act of 1986 was heralded as the greatest tax reform bill ever, history chronicles the bear market and recession that followed in 1987. This left one to ponder the real cause of this recession. It is clear that the tax bill had obliterated the supply side economic stimulus, especially in real estate ventures. By holding back tax shelter losses until profits were realized, people naturally looked elsewhere for suitable investments. Passive loss limitations still exist today and they have rarely been revisited since their enactment.

The current tax reform proposal does not address the substantive issues of outdated passive loss rules and fails to recognize the contribution to the economy of small real estate generated ventures at the middle-income level. Also, the opportunity to gentrify inner city blight through a strategic use of real estate tax shelters in places like Detroit, St. Louis and Baltimore is being overlooked. Allowing limited use of the 1954 Internal Revenue Code’s original tax shelters should be a part of the current proposal.

It is not clear that Trump’s proposed tax cuts can have the same impact that the Reagan tax cut strategy had. Reagan spurred the 1980s surge in economic growth, gentrification and ultimately wealth, but rival politicians saw this as a loophole. In reality, Reagan leveraged supply side economics into high gear and this worked to the overall advantage of the economy. The taxpayer made an investment that was expected to produce significant income but, more importantly, it immediately created new construction jobs over the next several years. Had the taxpayer not made that investment, the result likely would be protracted and prolonged urban squalor, such as the abandoned buildings in Detroit.

There were other contributing factors to the 1987 recession, but it was the tax bill that really penalized passive capital investors. Everything related to real estate immediately slowed down. All this bill seemed to do is to move that Reagan-era venture capital into the stock market. Most economists blame an overvalued stock market for the crash of 1987, but why was it overvalued? Consider the swing of investment capital from real estate to the stock market and you have a probable cause. Nevertheless, there was enough real estate wealth left in the economy to feed the ensuing George H.W. Bush years. Sadly, I don’t see the Reagan-like vision in the Trump proposal.

Patrick R. Colabella, CPA, is an associate professor in the department of accountancy at the Peter J. Tobin College of Business at St. John’s University and the author of “How to Get Rid of Socialism (And Solve the Fiscal Problems of the United States of America).” The views and opinions expressed in this article are those of the author and do not necessarily represent or reflect the views and opinions of St. John’s University.