We cannot afford to extend tax breaks for corporations or the wealthy that cripple our ability to invest in areas that expand economic growth, like infrastructure and education. Tax reform must be done in a way that raises significant revenue, protects working families and the vulnerable, and requires corporations and the wealthy to pay a fair share.
The primary goals of comprehensive tax reform should be to progressively raise sufficient revenue to (1) make investments that will grow the economy, and (2) set us on a path for long-term deficit reduction. Low- and moderate-income Americans are already contributing to deficit reduction through the Budget Control Act spending caps and are likely to be asked to sacrifice more. Progressive tax reform is the only way that wealthy Americans can share significantly in that sacrifice.
Rather than use the 1986 tax reform as a model, we should be taking cues from our last five balanced budgets (1969 and 1998-2001), which all required above average revenue. During these years of balance, federal revenue averaged 19.5% of GDP, substantially higher than the previous 40 year average (18% of GDP) and the pre-recession level (18.5% of GDP). However, with demographic shifts, the desperate need for job-creating investments, and the size of our current deficits, our revenue will need to be higher than even these historical levels to achieve balance.
The writing is on the wall: a revenue-neutral approach to tax reform – on either the corporate or individual side of the tax code – is not an option. Further, so-called “dynamic scoring,” that imagines revenue out of thin air and is widely refuted by respected economists of all political affiliations, cannot be used to shirk the requirement for revenue in deficit reduction proposals. We believe that any comprehensive tax reform must include the following six principles.
Corporate Tax Reform Principles
1. Revenue Positive
As the debate over our fiscal challenges proceeds, more and more constituencies have been asked to contribute to taming our deficit under the pretense of “shared sacrifice.” Yet time and time again, the corporate tax code has been given a pass. This asks nothing of corporations that continue to set near-record level profits and have largely recovered from our post-2008 economic slide, and requires the sacrifice of working families and the poor to be more severe. Plain and simple, the corporate contribution to our deficit reduction must increase from the status quo. As a share of GDP, corporate taxes have fallen from 4.7% in the 1950s to a scant 1.9% from 2000-2009. In 2007, the U.S. Treasury found that when evaluated on average corporate tax rates, the United States was second lowest among its competitors in the G8 and three percentage points below the Organization for Economic Cooperation and Development (OECD) nations’ average. Just this year, CBO data show that the effective corporate tax rate dropped to 12.1%, the lowest recorded level during the past 40 years. As a share of our total revenues, corporate taxes averaged 27.6% in the 1950s and have dropped precipitously since to 10.4% from 2000-2009. This is not a fair distribution of our tax burden.
How do we improve? We should advance the tax code’s efficiency, eliminate wasteful loopholes, broaden the base, and reduce bias towards overseas investments. However, the presumption that we should turn around and shovel this revenue out the door through lower marginal rates – particularly when we have huge needs for investment in areas such as infrastructure and education – is simply one we cannot afford.
2. Promote Responsible Corporate Behavior
In addition to being a means through which the private sector contributes to public goods and societal needs, the corporate tax code is meant to serve as a tool to fuel smart investments, and an economic instrument to incent clear, positive objectives. Comprehensive corporate tax reform should retain those expenditures that have proven to be an efficient and worthwhile investment in our nation’s future. This includes, but is not limited to, incentives to hire disadvantaged workers, invest in distressed communities such as the Low Income Housing Tax Credit, bring jobs home from overseas, help small businesses and promote clean energy and energy efficiency.
Further, we must eliminate tax loopholes that encourage reckless and undesirable behavior such as the overuse of debt financing and tax sheltering, and explore commonsense revenue streams like putting a price on carbon pollution or enacting a small financial transactions tax to reduce market volatility. We should also repeal the more than $95 billion in special tax breaks we are scheduled to give away to the established, highly profitable fossil fuel industry over the next ten years.
3. A Global System that Works for the American People
In addressing our serious revenue gap, we should reduce – not increase – the tax code’s bias towards overseas investment. Rather than fixate on top marginal rates, corporate tax reform should focus on what’s actually broken: our partial-worldwide system relying on deferral has not kept pace with the globalized business community. The status quo allows multinational corporations to achieve extremely low worldwide and domestic effective tax rates, encourages shifting of profits and investment overseas, and costs billions each year in US tax revenues. To harmonize 21st century commerce with our revenue needs, we should modernize our tax code by either ending deferral (and the excessive tax avoidance this encourages) or adopting a global minimum tax (rendering deferral largely irrelevant).
Yet some large corporate interests have marched to Capitol Hill advocating for a tax system that would worsen the tax code’s bias towards foreign profits and investment, and increase the deficit. They claim that the only way for the United States to remain globally competitive is to transition to a territorial tax system, which would levy taxes only on earnings in the country in which they are reported and exempt corporations’ offshore profits from US taxes. Their solution is wrong and ignores some very hard facts.
Such a system would increase the incentives and opportunities for multinationals to shift profits and investment offshore. While that might be good for corporate shareholders, it would not be good for America's workers. The non-partisan Congressional Research Service told Congress last year that a territorial system “would make foreign investment more attractive,” causing investment to flow abroad and reducing wages for US workers.
Regardless of rumor or political agenda, the United States remains the preeminent location for businesses in the global economy. According to the World Bank, the United States ranks first among large countries in the ease of doing business, which included more comprehensive measures of business-friendliness including regulation burden, property rights, access to credit, and contract enforcement, to name a few. There is no need to cater to the demands or large corporations, particularly when it would devastatingly undercut the investments we need to make in our infrastructure and human capital.
Individual Tax Reform Principles
1. Restore and Improve Progressivity
It is a bedrock principle of fairness that those with higher incomes should pay progressively higher tax rates. Any tax reform must ensure that each fifth of the income distribution (as well as the top 1% and top 0.1%) should have a higher average effective tax rate than the income group below. Across the board tax rate cuts are regressive because a 20% tax cut for a millionaire – even as a share of income – amounts to a far greater benefit than a 20% cut for a hardworking low income American.
To maintain or strengthen progressivity, we should end one of the leading contributors to after-tax income inequality in this country, the special tax breaks for investment income. Workers who get their salaries from wages often pay a higher effective tax rate than wealthy individuals like Mitt Romney and Warren Buffett who make most of their income from selling stocks and bonds or from dividends. This undermines the basic tenant that average tax rates should rise with income. In fact, the richest 1% of taxpayers receives 71% of all capital gains, while the bottom 80% of taxpayers receives only 10% of capital gains. We should treat all capital gains and qualified dividends as ordinary income, an approach President Reagan once signed into law.
We must also strengthen the estate tax, which is the single most progressive tax. The weakening of estate tax requirements over time has contributed to expanding income inequality for the top 1%. The current estate tax rules should expire and, at a minimum, we should return to 2009 levels as President Obama has proposed, which would impact only the wealthiest three out of every 1,000 estates.
2. Fair Rates for the Wealthiest Taxpayers
We must ensure that the wealthiest Americans are paying their fair share of taxes. While we applaud success, when the wealthy get tax breaks they don’t need and the country can’t afford, the middle class and working families make up the difference in cuts to programs like education and Medicare. What’s more, the income gains of the last three decades have not been distributed fairly. The wealthiest Americans’ have seen an outsized growth in income (155% income gains for the top one percent of earners compared to 41% income gains for the bottom 80 percent) and tax reform should not exacerbate these trends of gross income inequality. As studies continue to bear out, high levels of income inequality weaken the economic environment for all Americans.
As a first and minimum step, instead of giving an average tax break of $160,000 to millionaires, the Bush-era tax rates on the richest 2% should return to the rates we had when Bill Clinton was president and the economy was booming. As a recent Congressional Research Service report found, reductions in the top tax rates have little association with economic growth, although it found these reductions were associated with increasing income disparities.
There is a meaningful difference between a multimillionaire and a family earning $250,000 a year that our tax code fails to recognize. The simplest and most direct way to address our revenue needs while avoiding undue burdens on some upper-middle class Americans is to add additional tax brackets for the extremely wealthy as proposed by Rep. Schakowsky (H.R. 1124). Because the root of our tax code’s complexity stems from the web of deductions and tax expenditures, not tax rates, these new brackets could help raise additional revenue and improve equity without unduly hampering economic efficiency.
3. Reexamine Expenditures that Benefit the Wealthy; Protect those that Help Working Families, the Poor, and Seniors
Tax policy is economic policy, and tax expenditures are a form of spending. We must prioritize our spending through the tax code to remove expenditures that disproportionately benefit the wealthy, while protecting those that create ladders of opportunity, reward work, and protect the poor.
Subsidies that disproportionately benefit the wealthy should be made fairer and more efficient by targeting them better, such as by transitioning to tax credits. At the very least, we should cap the benefit of itemized deductions for families with incomes over $250,000 at 28%, as outlined in the President’s budget. Only one-third of taxpayers itemize their deductions because the majority of Americans claim the standard deduction. Further, the value of a deduction corresponds to an individual’s marginal tax rate, making itemization highly regressive.
We support tax expenditures that increase access to health care, homeownership, and a secure retirement. Tax credits that benefit seniors, the poor, or working families – such as the child tax credit – should also be protected with their refundability maintained. We support maintaining the improvements made under the American Recovery and Reinvestment Act to tax credits targeting working families, including the Earned Income Tax Credit, the Child and Dependent Care Credit, and the American Opportunity Tax Credit. In addition, as our economy continues to recover, we support tax credits to create consumer demand and assist low- and middle-income families such as the successful Making Work Pay tax credit.
We also must not fall for the trap of agreeing to a tax reform framework that sets a goal of locking in regressive and costly rate reductions while leaving for later which tax expenditures would be targeted. This would either result in lower overall revenue or would put at risk tax expenditures that benefit the poor and the middle class, and neither is acceptable.