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WSJ: Overhaul the Tax System Like It’s 1913, Not 1986

OG-AB456_THINKT_A_20140521152143Two weeks from Tax Day, taxpayer frustration is high. As lawmakers seek a path to tax reform, the lessons of the Revenue Act of 1913 and the Tax Reform Act of 1986 might be helpful to recall.

In 1913, the major source of revenue for the government was a complex, lobbyist-driven set of tariffs, which had become politically unpopular and economically unsound. Rather than fixing a tariff-based system, the Revenue Act of 1913 substantially lowered tariffs and instituted an income tax that became the chief source of revenue for the government.

In 1986, the country lived under a complex, unfair, and economically uncompetitive income tax. The Tax Reform Act of 1986 was an attempt to fix things. The act may have been successful for a short period, but today our revenue system is once again broken and, some say, beyond repair.

John McKinnon’s Wall Street Journal piece on Monday suggested that the time for a new type of taxation–as in 1913–may have arrived. In the last Congress, the chairmen of the congressional tax-writing committees, Rep. Dave Camp and Sen. Max Baucus, tried to fix the income tax but failed, because today’s tax preferences are too politically entrenched.

But a shift is emerging in thinking about tax reform, from fixing the income tax to replacing it with a consumption tax.

The evidence: the progressive consumption tax proposed by Sen. Ben Cardin (D., Md.) is getting respect in the Senate Finance Committee, which writes tax legislation. In conservative Republican circles, Sens. Marco Rubio and Mike Lee’s tax reform plan is getting rave reviews.

The Rubio-Lee proposal eliminates the tax on personal saving and includes a consumption tax for businesses. Sen. Orrin Hatch (R., Utah) and Rep. Paul Ryan (R., Wis.), chairmen of Congress’s tax-writing committees, are open to a consumption tax because of its positive impact on economic growth and U.S. competitiveness. Sen. Cardin, for example, would reduce the corporate rate to 17%, which is lower than the Republican goal of 25%.

Both Democrats and Republicans need to remember, however, that for American companies to be competitive, what is taxed (new investment, for example ) is as important as how much is taxed (the corporate tax rate).

Consumption taxes aren’t a novelty.  In the U.S., there are local sales taxes everywhere. The value added tax (VAT) is common around the world–its absence in the U.S. is an anomaly. Former Treasury Secretary Larry Summershas observed that the U.S. has no VAT because liberals think it’s regressive and conservatives think it’s a money machine. The U.S. will get a VAT, Mr. Summers has said, when those positions are reversed.

Sen. Cardin addresses “regressivity” by providing, for example, a large income tax exemption for joint filers making less than $100,000. He addresses the “money machine” issue by requiring that revenue in excess of 10% of GDP be returned to taxpayers. This 10% circuit breaker is an innovative idea that could open negotiations with conservatives and result in a compromise on a lower tax rate.

President Barack Obama, Rep. Ryan and Sen. Hatch want to start tax reform this year, beginning with the corporate sector. Replacing the corporate and business income tax with a consumption tax has political appeal and makes economic sense. Those who cannot learn from history are doomed to repeat it. And 2015 is more like 1913 than 1986.

Mark Bloomfield is president and CEO of the American Council for Capital Formation and co-authored “The Consumption Tax: A Better Alternative?” He is on Twitter: @MrCapitalGains.

On Capital Gains, Obama is no Ronald Reagan

 Published in The Hill

Hope for tax reform in 2015 was dealt a setback in President Obama’s budget with a proposed increase in the maximum federal tax on capital gains and dividends from 23.8% to 28%. In a coy move to entice Republicans to support this hike, Obama invoked Ronald Reagan, noting that their proposed top capital gains tax rates were one and the same.

As Secretary of President-Elect Reagan’s Transition Task Force on Tax Policy, and later helping shepherd legislation into into law, I can say with certainty that I was there and President Obama is no Ronald Reagan when it comes to taxation on savings and investment.

Over the years, capital gains taxation has evolved into a polarizing issue that is part economics, politics and religion. To Republicans it can be the holy grail. To Democrats it can be the Original Sin.

How did we arrive here? First, a bit of history. In 1978, President Jimmy Carter described the treatment of capital gains as “a huge tax windfall for millionaires and two bits for the average American.” He favored taxing capital gains at the same rate as ordinary income, which would have effectively doubled the rate for many taxpayers.

Carter’s message fell flat among the business leaders from Silicon Valley and across the country. They mobilized and made the case that capital gains tax rates shouldn’t just be preserved, they should be reduced to help spur much needed economic growth and jobs. The message resonated, and a bipartisan group of lawmakers led by GOP Rep. William Steiger of Wisconsin came together with unlikely characters, including Democratic Rep. Kenneth Holland, who represented a poor district in South Carolina. Holland believed that lower capital gains rates could be an important ingredient to job creation and his constituents. In October 1978, the Steiger bill passed both houses and was signed by President Carter, reversing a tragic tax hike into a dramatic cut. This also ushered in an era that shifted tax policy focus from income redistribution to economic growth in the eighties.

Enter Ronald Reagan, who ran his presidential campaign on a pro-growth platform that Americans were being taxed too heavily and that our was stifling innovation, risk taking and entrepreneurship. In 1981 he made a cut in the top regular tax rate on unearned income, which reduced the maximum capital gains rate to only 20%—its lowest level since the Hoover administration.

Several years later, after an epic political battle over the 1986 Tax Reform Act, President Reagan compromised on capital gains tax for the good of overall reform and allowed rates to be set at the same level as the rates on ordinary income, with both topping out at 28 percent. Reagan didn’t relish raising the capital gains tax rate to 28% but was willing to compromise on taxing capital gains as ordinary income since overall rates were being dramatically reduced for Americans.

Like Reagan, many Democratic leaders understood the importance of capital gains tax rates to the economy. JFK eloquently said, ”The tax on capital gains directly affects investment decisions, the mobility and flow of risk capital from static to more dynamic situations, the ease or difficulty experienced in new ventures in obtaining capital, and thereby the strength and potential for growth of the economy.”

When FDR, who was known for a “soak the rich” approach to tax policy, and large Democratic congresses ran the country, they adopted a capital gains tax sliding scale—the longer an asset was held the lower the rate it paid. By claiming to encourage “investment” rather than “speculation,” Roosevelt and Democrats were able to satisfy the populists in their party.

Today, Democrats say a hike on capital gains taxation is a lifeline to the middle class, Republicans say it is Robin Hood economics. In reality, a low capital gains tax rate has an important role to play in fostering economic growth and in promoting the entrepreneurial drive, which is why Silicon Valley became ground zero for the Carter revolt on capital gains tax hikes. Entrepreneurs are a major force for technological breakthroughs, whether its replacing an old lathe or coding the latest app. It’s a shot in the arm that can encourage risk taking for new start-up companies and the creation of high paying jobs. The economic ripple effect touches everyone—middle class and the wealthy.

Economic research shows that tax policy, particularly when it comes to capital gains, can have a significant bearing on economic growth. A 2010 study by Dr. Allen Sinai, President and CEO of Decision Economics, Inc., found that raising the nation’s top individual capital gains rate by 5 percentage points to 20 percent would cut real annual economic growth by an average of .05%. These calculations at the time did not include 3.8 percent unearned income tax. Imagine the impact of hiking the capital gains tax rate to 28%.

For many, the fed hit is just the beginning. In many cases investors face a double or triple whammy depending on where they live. Combined with the state capital gains tax rates, and in some cases local, a higher federal capital gains tax rate will likely result in fewer investments being undertaken.

Beyond the impact on our economy domestically, capital gains tax rates have also had a bearing on our international competitiveness. A now outdated report by Ernst & Young LLP compares individual long-term capital gains taxes that were raised under President Obama among major economies of the world as well as major trading partners of the U.S. The U.S. capital gains tax rate compares unfavorably with that of many other major economies including Canada, Australia, Japan and Russia. Wait until the new numbers are crunched under the Obama proposal.

President Obama can draw a line in the sand on capital gains rates, or he could take one step over it and be in the good company of his predecessors, like Reagan, JFK and FDR who realized their importance to the economy and found common ground.

Mark Bloomfield is President and CEO of the American Council for Capital Formation, a nonprofit, nonpartisan organization dedicated to public policies supportive of saving and investment to promote long-term economic growth, job creation and competitiveness. He also served as Secretary to President-Elect Reagan’s Transition Task Force on Tax Policy

At an October Heritage Foundation event on Tax Reform, I share perspective from efforts in 1978, 81 and 1986.  I offers 6 lessons from tax reform past and also his thoughts on income inequality, best-selling author and French economist Thomas Piketty and how each plays a role in the current economic and political climate.