The tax deductions for state and local taxes and for charitable gifts
Together these breaks cost the Treasury about $90 billion last year (not counting the deduction for local property taxes). While these are popular deductions, no economic logic supports them; they amount to federal subsidies for state and local taxation and for philanthropy, although there’s no reason to support those activities at the expense of countless others.
We wouldn’t ax all special breaks. We’d keep the Earned Income Tax Credit, which is an important source of support for low-income workers with kids. Liberals like the EITC because it’s a surviving bit of federal welfare; conservatives like it because it was championed by Ronald Reagan.
Those changes let us improve the individual income tax in a couple of important ways. One, we can drop the AMT. The alternative minimum tax is the outgrowth of a clumsy 1967 attempt to keep a handful of ultra-high-income people from totally avoiding federal income tax. But it has morphed into a monstrosity that whacks mainly middle-class and upper-middle-class taxpayers. Besides, we’re eliminating many of the mechanisms for tax avoidance. Two, we can significantly lower tax rates across the board. The Simpson-Bowles commission made a rough calculation that a structure similar to what we’ve outlined would bring in the same tax revenue we currently get but with just three tax brackets — 9 percent, 15 percent and 24 percent, all much lower than today’s rates. It’s a simpler, broader, fairer system.
The same principle — broaden the base, lower the rates — applies to corporate taxes. Tax expenditures for corporations aren’t nearly as expensive as those for individuals, and in the realm of corporate tax breaks, those targeted at specific industries — oil and gas, insurance, renewable energy — are only a minor percentage. Such corporate welfare is small potatoes economically, but we’d still eliminate it for the same reasons we’d drop special breaks for individuals: They increase taxes for others and distort incentives. They also carry significant symbolic value.
But the biggest corporate tax expenditure, by far, is the deferral of tax on income earned by multinationals abroad. Your authors confess they don’t yet see eye-to-eye on the best solution: One of us favors a territorial system in which U.S. companies pay the tax levied on income in each of the countries where it’s earned; the other favors a global system in which U.S. companies pay U.S. taxes on all their income but get credits for cash taxes paid abroad. We’ll keep working on it. In the meantime, what we agree on would simplify the system and allow the current rate (35 percent) to be cut without loss of revenue.
We’re proposing major tax and budget reform. Some people would argue it can’t possibly happen. But our differences notwithstanding, both your authors are congenital optimists. Major reforms happened under Kennedy and Reagan, and if our country gets a big enough scare, they could happen again. These things have their moments. As the economy cries out for help — for adult supervision at last — just maybe the moment has arrived.
Sloan and Colvin are senior editors at Fortune magazine. To read Sloan’s previous columns, go to postbusiness.com.