Death to the tax code?

This piece originally appeared in the New York Daily News.

During the presidential campaign, President Bush unveiled a bold second-term economic agenda that included fundamental tax reform. Shortly thereafter, Alan Murray wrote in The Wall Street Journal that the Bush administration was taking another page from the Gipper’s playbook — tax cuts in the first term, tax reform in the second.

If Murray is right, then the playbook provides a cautionary tale: Tax reform is not reform if we merely close some loopholes and cut a few pages from the tax code but leave intact a destructively broad definition of taxable income.

Remember, by 1986 Ronald Reagan had succeeded in reducing the top marginal tax rate from 70% to 28%. The mistake made in the 1986 “reform” was increasing the capital gains tax rate to 28% and treating capital gains as ordinary income. The result: Capital gains tax revenue, which was greater than $165 billion in 1985, dropped precipitously to $116 billion in 1992.

Capital gains is not ordinary income; it constitutes an increase in asset values, and to tax that increased value is like putting a tax on capital itself. It’s like taxing not only the proceeds from selling apples, but also taxing the increased yield of the apple tree as it matures.

In 1996, the last time fundamental tax reform received a serious public hearing, I chaired the National Commission on Economic Growth and Tax Reform — the Kemp commission. We ultimately decided the current income tax system was “impossibly complex, outrageously expensive, overly intrusive, economically destructive and manifestly unfair.” The best course of action, we concluded, was to scrap the code and tax all income, but tax it only once. This would radically simplify taxation and create the conditions for long-term, robust economic growth.

Since the Kemp commission, capital gains tax rates have been reduced twice: in 1997 and 2003. Individual income tax rates have also gone down as a result of the Bush tax cuts, but the current top rate of 35% is still well above the 1986 level of 28%. What’s worse, the pro-growth elements of the 2003 tax cuts are set to expire, some at the end of this year.

The system is still impossibly complex, outrageously expensive, overly intrusive, economically destructive and manifestly unfair. We should scrap the code.

On the corporate tax front, America is falling behind its global competitors. In 1986, the U.S. cut the federal corporate tax rate from 46% to 34%.

Since then, the rest of the world has caught up and surpassed us in corporate tax competitiveness. Today, the U.S. has the fourth-highest corporate tax rate among Organization of Economic Cooperation Development countries, further proof that the real problem facing job creation is not “Benedict Arnold CEOs,” as John Kerry and many Democrats maintain, but a confiscatory, confusing and overly complex tax system.

If we cannot scrap the system outright, we should consider an attractive alternative, known as “the five easy pieces” approach — five changes that could reform the tax code from the inside out and give the economy an immediate boost:

(A) Lower marginal rates to at least 25%. (B) Eliminate the double tax on corporate earnings and returns to capital. (C) Accelerate depreciation, ultimately to 100%, for business capital investment. (D) Expand Roth IRAs to include all personal savings. (E) Exclude export and other foreign trade income of U.S. companies from taxation, as many other countries already do. None of these steps is strange or exotic. In fact, Bush endorsed the five easy pieces after an economic summit early in his first term.

This approach would maintain the American tradition of taxing income while lowering the exorbitantly high marginal tax rates that discourage work, penalize personal saving and depress business investment. And it would do it without a fight from every interest group with its own line item in the tax code.

No matter what shape tax reform takes, we must keep our eye on the ball, maximizing growth by removing the current code’s disincentives to work, save, invest and take risks. By enacting reforms like these and creating personal retirement accounts to transform Social Security, we will take a giant step toward democratizing capitalism in America.

Kemp is a former Republican congressman and vice presidential candidate. He is now co-chairman of FreedomWorks.

Originally published on November 13, 2004