To the pols: think beyond the fiscal cliff

A consistent refrain I hear from the top 1% taxpayers is that they would be willing to pay higher federal income taxes if the added tax revenues were used to reduce the country’s gaping budget deficit and soaring debt level.

That generous but hard-nosed perspective raises the grand challenge to President Obama and the Congress: the fashioning of a federal tax package for the long term economic health of the country that is more effective, more fair and more competitive.

The early sparring over a “grand bargain” between Democrats and Republicans evokes a picture of “small ball” – anything but grand. Yale law professor Bruce Ackerman reminds us that the 20th Amendment was written to limit the damage that could be done a lame duck Congress. He’s right that it shouldn’t cobble together any long-term legislation.

The current office-holders should avoid the fiscal cliff with a short-term patch and then leave the heavy lifting to the new Congress being seated in January.

Major shifts in tax and spending policies then need to be grounded in sound policy principles, not payoffs to big donors. Here are some pragmatic planks that various voices have offered as “long ball” strategies:

• Make sure our corporations are competitive around the world. The best “welfare” for 99% of citizens is a good job, and those good jobs are either offered by private sector companies or paid for in the public sector by tax revenues from those companies and their employees. Businesses are tax generators; necessary public entities are tax users. Ergo, lower the corporate income tax rate from 34%, highest in world, to about 25%, near the average for industrialized countries. Ireland is the lowest at 12%.

• Offset the lower rates with an alternative minimum tax (AMT) of, say, 20%, on corporations. Some large corporations pay zero, thanks to heavily lobbied tax breaks. That’s just not right and it hurts tax collections badly.

• Billionaire Warren Buffet, multi-millionaire Sen. Herb Kohl and best-selling author Barack Obama want the rich to pay higher tax rates. Unfortunately, the AMT tax hasn’t gotten that job done. (The president paid 20.5% last year; Mitt Romney 14%.) For those successful citizens, the minimum rate ought to be at least 30%. Allow no AMT loopholes for the super-rich, say anyone making more than $2 million per year.

• Tax the rate up to the pre-Bush 39.6% for those over $500,000, a compromise level, but predicate that rate on a balanced federal budget. If the red ink can be stanched in the annual budget, the economy will grow enough to get the deficit back into proportional balance.

• Keep the current rates or bring them down for the “middle class.” (The lower 40% of income earners pay no tax now.)

• Pay for the lower personal and corporate rates with consumption taxation, a value-added tax at the federal level. Surveys show that large majority of citizens view sales taxes as the least painful, even if they are regressive. Continue to offset the regressivity with earned income tax credits, in effect a negative income tax that gives cash to low-income households.

• Eliminate the estate tax, called by some the death tax. It amounts to double taxation, doesn’t raise much tax revenue, causes elaborate tax avoidance schemes, accompanied by enormous professional fees that accomplish little for society. Prof. Ackerman suggests a 2% wealth tax as an alternative.

• Eliminate most loopholes in favor of lower rates. Keep the deduction for charitable donations; America is the most generous country; keep it that way; there are a gazillion good causes, and the government can’t pay for them all. (Buffet, Kohl and Obama are exemplary philanthropists.) End the deductions for state and local taxes, which indirectly encourage higher state and local rates. End the mortgage interest deduction on more than one residence.

• Keep the capital gains and dividends rates low to encourage investment. The current 15% really does encourage investors. But change the “carried interest” earned by fund managers from capital gains treatment to ordinary income. It is their “ordinary” income. The AMT could also solve that discrepancy in the code.

• Encourage entrepreneurs, the source of all net new jobs in the country. Do what Wisconsin and Minnesota have done. Give a 25% tax credit at the federal level for early stage investing in startups. Over time, that would be the best tonic for long-term prosperity in the country.

Let’s be realistic. Vested interests, which spent more than $2 billion on both sides of the national elections, will fight furiously for their tax breaks and budget goodies. They will call in all their political chits before a “grand bargain” can be stuck.

But, in the end, good policy makes for the best politics. We didn’t send our representatives to the Capitol to play small ball.

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  • George Patterson

    Good stuff John/well thought out and very fair. Are you sure you dont want to run for office

    • JohnTorinus

      I’ve been in the cheap seats with journalists for too long.

  • Denny Caneff

    John, it’s great to see the word “stanch” used right. Many writers confuse “stanch” with “staunch.” Thanks for taking on the stench-ridden world of tax reform.

    • JohnTorinus

      I stole the word from the tax grinch.

  • jhinwb

    OMG, someone makeing sense, very impressive way to cover the issues….the 25% corp rate would be great if there were positively no credits or deductions, and there should be some ceiling on the mortgage deduction.

  • David Baldus

    That’s the revenue side…how about the expense side?

    • JohnTorinus

      That’s in a coming blog. Thanks for the prompt.

  • tim nixon

    John,

    I have not seen the VAT suggested other than in my musings to a couple of friends. Although regressive, it grabs a lot of revenue from folks not paying any tax other than FICA and Medicare as payroll deductions. More important, it taps the off-the-books cash economy, the size of which is very tough to estimate accurately. A very small VAT could be a huge revenue produce without a lot of people noticing.
    Tim Nixon

    • JohnTorinus

      Good points, Tim.

  • Phil Hauck

    Agreed, but consider two other thoughts …
    • I’ve always felt that income taxes on “businesses” should be zero. They are the cash cow, the originator of all private sector jobs (that will provide public sector job funding) … and money not taxed will be used for business development in one form or another. If it is doled out to the owners, that will be taxed. Figure out some way that LLCs, etc., can leave money in the business.
    • Regarding the 15% capital gains tax, huge amounts of capital gains come from non-value-adding investments (i.e., the stock market). Tax those at ordinary income rates a la Mr. Buffet’s concern. Have another way of capturing dollars that are “invested in businesses,” so that income can be taxed at the lower, 15% rate.
    Phil Hauck

    • JohnTorinus

      Hadn’t heard that idea on capital gains before, but you are certainly right that the big impact investments are those made into early stage companies.