TAX OVERSIMPLIFICATION

On Tuesday of last week, President Obama gave a terrific speech at Georgetown University, explaining and defending his approach to the economic crisis better than at any time to date. His message for Americans was that:

“… each action we take and each policy we pursue is driven by a larger vision of America's future - a future where sustained economic growth creates good jobs andrising incomes; a future where prosperity is fueled not by excessive debt, reckless speculation, and fleeting profit, but is instead built by skilled, productive workers; by sound investments that will spread opportunity at home and allow this nation to lead the world in the technologies, innovations, and discoveries that will shape the 21st century. That is the America I see. That is the future I know we can have.”

For a short while I felt much better about the prospects for a new-style American economy. Obama’s ringing statement was at least the beginnings of the sort of national strategy I’ve been seeking for several years now. Some of what has passed for “stimulus” thus far might not serve the President’s “larger vision.” But this strong statement set forth a real test for future policy – it should promote future investment, economic growth, jobs and incomes. Bravo!

Then the following day (not coincidentally, April 15), the President set an objective for change in a major policy area that left me scratching my head. He directed his Economic Recovery Advisory Board headed by Paul Volcker to come up with recommendations for tax reform by the end of this year. In doing so, he left the impression that he sees the big problem as the “monstrous” complexity of the tax code.

The focus on tax and the sense of urgency are commendable. The code does run to over nine million words. Compliance is a nightmare for average citizens and a challenge even for smart CPAs. It’s full of special-interest gifts and replete with essentially failed social policy (think of the many provisions related to health care, savings, and retirement).

Yet you don’t have to be a cynic to be skeptical about the benefits of tax simplification, particularly as they relate to our central problem: as a country we don’t produce enough to satisfy our needs and pay down our debt to the world. Simplification of the tax code, even if it were to materialize as intended, would not by itself address this problem. Our code is not just overly complex; it rewards the wrong behavior. Alongside simplification, let’s hope that Volcker will broaden the agenda to include:

a) lack of any border-adjustable consumption tax. Such a tax – like a value added tax or a national sales tax – can be rebated when goods are exported and imposed when they are imported. Virtually every US trading country does this, and it’s allowed by international law. The unsurprising result is that we have a persistent, massive trade deficit.
b) relatively slow depreciation rates. The US forces businesses to recoup the cost of investment, particularly major ones, over relatively long periods, thereby increasing the cost of capital. The result is to steer investment away from the US to a more generous country, such as Canada.
c) high corporate income tax rates. In 1986 when the US last undertook an overhaul of the tax code, one objective was to reduce the marginal corporate tax rate to match or overmatch the rates in the OECD area. We succeeded in that, but the world did not stand still. Within a short time, the US once again had the highest marginal rates in the developed world.

Simplification is not the be all and end all of tax reform. If we’re serious about regaining international competitiveness and the long-term integrity of the dollar, we need to aim for more than mere simplification of that monstrous tax code. Let’s get a first-class tax system for now and for the future.