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What’s Standing in the Way of Tax Reform? It’s Complicated

August 19, 2016 3 Min Read Tax Strategy, Business Tax
Michael R. Viens, CPA Retired, Former Director, Tax Strategies

The top U.S. corporate income tax rate of 35 percent is one of the highest in the world, a fact that many economists assert negatively impacts both owners and employees of U.S. companies. This high rate reduces the amount of earnings available for reinvestment in new productive assets or for distribution to shareholders and is seen as an important contributing factor to the relatively stagnant wage growth of the last decade.

Advocates for lowering corporate income tax rates argue that some of the corporate tax revenue that would be lost if corporate rates were substantially lowered would be offset by higher tax collections from a greater pool of earnings as well as from increased personal income tax revenues from higher wages ultimately paid to employees.

An argument can also be made that personal income tax rates are too high. A good case can be made that an income-based tax system has fundamental disadvantages and that any major tax reform initiatives will need to shift to a greater emphasis on a consumption-based system.

Changes to the U.S. tax system have been advocated for many years, although the exact nature of the proposed reform has varied over timeIn some quarters, a flat tax system would be the way to go. One of the fundamental obstacles to gathering the broad-based support needed to actually achieve a meaningful level of change lies in basic elements of anxiety about who the winners and losers would be when the smoke clears. For instance, what would happen to the value of your home if the changes are made to the current tax treatment of mortgage interest? Should your assessment of benefit be measured by whether you are in a better position than before or, rather, from a sense that someone else came out with a better outcome?

Those individuals who are likely to be negatively affected by tax reform will resist fundamental change as a result. On the other side, potential tax reform “winners” do not necessarily have strong perceptions about the economic gains they would achieve, so they may not be highly motivated to carry the banner for change.

Winners and losers aside, a common consensus may be found in the principle that any tax reform should be rooted in making the system simpler and more efficient, which would lead to a higher perception of fairness. But as you might suspect, there are divergent views on exactly how to accomplish these objectives.

Fundamental tax reform will require finding an appropriate balance between achieving desired enhancements for large corporate taxpayers while not doing so at the cost of small business owners. Some would argue that lowering corporate tax rates should apply equally to all forms and sizes of businesses. However, there would need to be some consideration for the potential impact of across-the-board business tax rate reductions as well as for individual taxpayers who may seek alternative compensation arrangements to wages so as to not be at a disadvantage from their neighbor who takes distributions from his or her business to supplement relatively modest wages.

The politics of tax reform are themselves potentially formidable obstacles, independent of the differences of opinion about the economic model that would be the best fit for sustained economic growth. No doubt, the political events of the next few months will provide many opportunities to highlight this.

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Michael R. Viens, CPA

Michael R. Viens, CPA

Retired, Former Director, Tax Strategies

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