Tax Reform Solves Two Problems: complexity and competitiveness

• Tax day is a disappointing reminder that the U.S. has not enacted tax reform in 30 years.

• This year, Tax Freedom Day – the day the country earns enough money to pay off its tax bill – will not come until one-third of the way through the year.

• The Obama administration released new regulations trying to make inversions more difficult. To fix the true problem, we need a more competitive tax code. It is currently the least competitive in the developed world.

AN OVERLY COMPLEX TAX CODE

Two April events remind Americans that tax reform is sorely needed: Tax day will cause hours of heart-ache for taxpayers; and new regulations from the Obama administration regarding inversions could make our international tax system even more complicated.

America’s bloated tax code continues to grow more complex. The IRS estimates that the average tax return takes 13 hours to complete – including related requirements like record keeping. The average business return takes 22 hours; the average individual return takes eight hours. Americans would much rather spend this time with their families or working to earn more money.

Average time spent on taxes is exceedingly high

In addition to the hours wasted on complicated paperwork, the IRS says that the average taxpayer has to spend hundreds of dollars preparing and filing a return. The process could be much simpler by removing many tax provisions and lowering rates. The last time the federal government simplified the tax code was 30 years ago. While the 1986 reforms got rid of many complicated provisions, a lot of them have been added back.

Some tax expenditures are good policy, and there are legitimate reasons for including them in the tax code. Others serve no compelling government interest and make taxpayers with equal incomes pay unequal taxes. Special tax breaks for certain activities that are favored by Washington only increase the public’s perception that the tax system is unfair.

Taxpayers are also working a long time to pay off their federal and state taxes. The Tax Foundation measures how long it takes the country to earn enough money to pay off its tax bill for the year. This year, Tax Freedom Day will come on April 24, almost one-third of the way through the year. Americans will pay nearly $5 trillion in taxes to federal, state, and local governments – 31 percent of GDP. This is more than people will spend on housing, clothing, and food combined.

NON-COMPETETIVE TAX RATES ARE THE PROBLEM, NOT INVERSIONS

Last week, the Treasury Department issued its third round of regulations to limit corporate inversions. The regulations unilaterally disregard legal acquisitions that took place in the last three years for the purpose of judging whether to apply other inversion rules.

Also, under section 385 of the tax code, the existing practice is to treat “an interest in a corporation” as stock or as debt. The new regulations would allow Treasury to treat this interest as part stock and part debt. This is meant to address the practice of “earnings stripping” that the Obama administration has criticized. This opens up every loan between related foreign and American corporations for audit by the IRS. It also imposes enormous compliance costs.

The Obama administration launched this regulatory attack in an effort to tax profits that businesses earn overseas. The vast majority of other developed nations do not do this – they have a territorial tax system in which they only tax profits made inside their borders. Republicans would like to move to a territorial tax system; and, until recently, Democrats agreed. President Obama’s former Treasury Secretary Tim Geithner supported a territorial system, as did four of the president’s advisory groups.

Corporate inversions are being driven by the high U.S. corporate tax rate. At 35 percent, it is the highest in the developed world. The right approach is to reform the code and lower the rates, not to spend years writing regulations that target only the symptom rather than the disease.

TAX REFORM NECESSARY NEXT YEAR

Congress can and should rewrite the tax code so that it is simpler and more competitive. It would free businesses to do what they are in business to do – and families to do what they want – rather than waste time shuffling paper for the IRS. The efficiency that results from thoughtful tax reform would help our economy to grow, and would restore Americans’ faith that their government is capable of coming up with good reform when it is needed.