Tax reform lives. House Ways and Means Committee Chairman Kevin Brady, Texas Republican, and other Republicans leaders will soon present a comprehensive plan to overhaul the federal income tax. Then Congress’ tax-writing committees, led by Ways and Means, will get down to the hard work of cementing the details.
The most difficult parts of the plan – the tax increases to pay for lower tax rates – remain in flux. That’s a good thing. Lawmakers still have the chance to find compromises that can soften the blow from big tax hikes. The best way for lawmakers to draw such a conclusion is to focus on a single number: the effective tax rate.
The effective tax rate is the amount that’s actually paid in taxes by an individual or a company, expressed as a percentage of income. It is, in other words, tax reform’s bottom line.
To figure out winners and losers in a tax proposal, all lawmakers need to do is calculate whether the total amount of taxes paid under the plan is less than or more than the amount that’s being paid under existing law. In other words, they need to use the effective rate. Such a calculation will be vital in tax reform, which lowers tax rates while ending tax benefits – all at the same time.
What we know already about the tax reform plan is good for Americans and American commerce. It will stimulate the economy and improve U.S. competitiveness. It will also deal with both corporate taxes and the taxes paid by individuals as well as the taxes paid by businesses known as pass-throughs that pay taxes using the individual tax-rate system. That’s why it’s been dubbed comprehensive.
It has all the makings of the kind of reform that will fix the broken U.S. tax code. It lowers tax rates by eliminating tax preferences. Its authors have also hinted that it will simplify the corporate income tax so it applies more evenly – and in that way more fairly – across various industries.
That would be important. The current system is hobbled because it allows disparities in effective tax rates paid by different types of businesses. That makes no sense. Two companies in the same business often pay different effective tax rates. A reason is sometimes that one is organized as a corporation while the other is a pass-through.
For example, wholesaler-distributors, which are among the largest employers in the U.S., are taxed at an effective tax rate that is significantly higher than many other industries – in the 30 percent or higher range. This contrasts sharply with other industries whose effective tax rates are often in the teens or lower.
The tax reform plan that’s forthcoming should avoid creating new disparities between businesses and industries.
The best way to make sure the next iteration of reform is a success is to view it through the lens of effective tax rates. Chairman Brady and other lawmakers need, in fact, to use effective tax rates as the primary guide to achieving comprehensive reform for all types of businesses.
Reliance on the metric of effective tax rates will strengthen the economy by replacing today’s government-selected winners and losers with a leveler playing field. It will also bolster the effort to enact reform that broadens the tax base while lowering tax rates for corporations, pass through businesses and individuals alike.
Disparate effective tax rates – of the kind that the code allows today – hinder job creation, economic growth and the competitiveness of American businesses. Simplifying the tax code in a way that reduces effective tax rates and narrows the effective rate disparity among industries and business types is the key to designing a reform that works for everyone.
Published in Daily Times, October 30th 2017.