Tax Reform by 2016? Maybe

Published in Barron's Magazine

By Jim McTague

Rev up the congressional saw mill! Republican control of Capitol Hill in 2015 and 2016 should break the huge legislative logjam that has existed since 2011 between the GOP-controlled House and the Democratic-controlled Senate. The angry elephants will shoulder aside stubborn donkeys and move dozens of their bills bottled up by Senate Leader Harry Reid because they were inimical to the big-government agenda of President Barack Obama.

The Republicans also promise to produce a tax-reform bill for the president to sign. There’s every reason to believe this will be so. There’s bipartisan support in both the House and the Senate for junking the current tax code and replacing it with one that is simpler and that makes the U.S. more competitive internationally. The business community has convinced both parties that the current system is hobbling the recovery. Give them a break and they will spend, they claim.

Getting the president to sign a Republican-endorsed bill—well, that’s a whole other story. Obama has strong preferences regarding the shape of tax reform—and he shows no sign of abandoning them merely because Republicans now have the run of Capitol Hill. Ideologues like Obama don’t like to compromise. The president revealed his distaste for compromises at his post-election news conference Wednesday.

“THERE ARE GOING TO be some ideas that I’ve got that I think the evidence backs up would be good for the economy, and Republicans disagree. They’re not going to support those ideas. But I’m going to keep on arguing for them because I think they’re the right thing for the country to do. There are going to be some ideas that they’ve got that they believe will improve the economy or create jobs that, from my perspective, aren’t going to help middle-class families improve their economic situation, so I probably won’t support theirs, ” he said. In short, Obama indicated that he’s not prepared to budge from the stances he’s taken since day one in office.

Because of his take-it-or-leave-it style, the logjam between the House and the Senate could be replaced by a logjam between Congress and the Oval Office. Obama has a drawer full of veto pens and he’s indicated that he’s not afraid to wield them. Accordingly, “there’s a great deal of uncertainty about the fate of taxes,” says Douglas Holtz-Eakin, a former director of the Congressional Budget Office and currently president of the American Action Forum, a center-right policy institution.

“While last Tuesday’s outcome was a great political victory for Republicans, I’m not sure how far it advances the policy ball,” Holtz-Eakin says.

Obama favors the a tax-reform “framework” that’s in his fiscal 2015 budget. It would lower most corporate rates from 35% to 28% and would reward manufacturers with a special 25% rate for keeping jobs at home. The president would levy a temporary tax on the earnings kept overseas by U.S. companies and use the revenue to fund infrastructure projects, such as roads, bridges, waterways, and ports, and a better air traffic control system. Mercifully, he did not mention those spurious high-speed rail projects he had championed prior to the election.

In the president’s mind, his tax framework should appeal to Republicans because it lowers rates and generates money for infrastructure improvement. Economists left and right—including Ben Bernanke when he was Federal Reserve chairman—have suggested infrastructure investment to strengthen the pace of the recovery. However, the president’s penchant for disparate tax treatment of different industries flies in the face of fairness and sound economic policy. Every business should be equal under the law. Free-market economists argue that you shouldn’t have one tax rate for the shoe maker and another for the shoe store. Republicans pretty much rejected Obama’s outline when it appeared for this reason and also because it provides no relief for small businesses, which tend to pay taxes at the individual tax rate.

Mark Bloomfield, president and chief executive of the American Council for Capital Formation, a man steeped in the history of tax battles, says we are unlikely to see stand-alone business tax reform, simply because it never has happened before. Politicians aren’t inclined to cut taxes for corporations without providing commensurate relief for the little guys, he observes.

MULTIPLE PLANS ARE IN various stages of development in both houses of Congress that could become the basis for bipartisan tax-reform bills. Retiring Michigan Rep. Dave Camp, chairman of the House Ways and Means Committee, produced a 979-page blueprint that cuts rates for corporations and individuals by reducing tax preferences (see “Dave Camp’s Last Chance,” April 14, 2014). But his plan only reduces the highest individual tax rate to 35% from the current 39.6%. His GOP colleagues want a much lower top rate.

Wisconsin Rep. Paul Ryan, who likely will become the next chairman of the House Ways & Means Committee, favors a plan that relies on projected revenue growth from “dynamic scoring” to reduce the top individual rate to about 25%. Dynamic scoring attempts to predict taxes’ impact on the macro economy. Opponents say the estimates are more theoretical than credible. You’ll hear cries of “voodoo economics” if this plan rolls through Congress.

In the Senate, Utah’s Orrin Hatch, who likely will become Finance Committee chairman in the 114th Congress, has collaborated with Oregon Democrat Ron Wyden, the current finance chairman, on a series of hearings designed to pave the way for a simplification of the individual and corporate tax system. We expect Hatch to outline his tax position in detail after he is formally named chairman.

Tax reform by 2016 is a strong possibility if the GOP is prepared to buy Obama off with a big infrastructure package. Watch the construction sector for clues: A sudden rise in equipment and materials stocks would signal that a deal is in the bag.