What’s Your Top Ten List for Tax Reforms?

by Linda Beale
(cross posted with ataxingmatter)

What’s Your Top Ten List for Tax Reforms?

Tax Prof’s ongoing discussion of potential tax reforms to be suggested to the Volcker Commission got me thinking what my own “top ten” would be. I’ll list them here, but I invite readers to provide their own as well. (Much of my reasoning is expanded in prior posts on most of these issues.)

1. Eliminate CG preference (and in the process repeal 1(h)(11) providing dividend taxation at preferential rates).
You can read my prior posts on this, too, of course. But briefly:

Capital gain preferences are enjoyed primarily by the wealthy, who hold the vast majority of the financial assets. The country has witnessed massively increasing inequalities, with ordinary workers’ wages stagnating while top earners salaries and bonuses soar to egregiously overblown heights (especially when one considers that those very earners are often the ones whose speculation was a key factor in the Great Recession). The theory behind capital gains preferences–according to all those pundits, Chicago School economists, and conservative supporters–was that it would free up capital for entrepreneurial investment, creating broad-based economic growth that would benefit everyone with jobs and better standards of living. Well, we tried that experiment for several decades. It simply hasn’t worked. What better proof than the Great Recession, which took place after eight years of generous tax cuts for capital?

Given the power of corporations and their managers’ and shareholders’ abilities to use the corporate form to aggrandize and use that power, I do not think that corporate integration is the right answer. Even if we don’t eliminate the capital gain preference, we should eliminate section 1(h)(11) preferential treatment of corporate dividends.

2. Tax holdings of marketable securities under 475 mark-to-market accounting

Those who hold lots of stocks and bonds of publicly traded companies currently get to defer their tax until they have some reason to dispose of assets–which may be to recognize a loss that they can use to offset other income. They currently can cheat fairly easily if they want to on the amount of gain reported, since third parties don’t track and report their basis. (Academic studies say significant cheating on basis takes place.) If they are lucky (and many are), they will not sell much of their holdings and will pass on the assets at a stepped up basis at death to their heirs, who can then sell tax free. Ordinary workers, however, must pay tax concurrently on receiving their income (and it is even taken out by withholding). This timing favoritism for capital income should end. Mark to market accounting for publicly traded financial assets would be relatively simple and permit third party reporting. (This is something that Mary O’Keeffe and others have recommended before.)

3. Repeal the R&D credit

Much of the basic research that underlies real development is done by universities anyway. Drug companies shouldn’t get an R&D credit for adding a tiny change to a patented compound in order to extend a patent beyond its current life, etc.

4. Repeal the special manufacturing deduction section 199

This is easy. This manufacturing deduction is really just a complicating corproate tax giveaway. Set the rates where they should be. No reason for manufacturers (especially as defined in this code section) to get special breaks.

5. Repeal the various subsidies for the natural resources extractive industry

If we want clean energy, we need to direct our incentives towards developing clean energy. Why don’t we let the energy department do that with directly funded subsidies–can you imagine the increased citizen involvement and transparency that would result? Get rid of these subsidies in the Code–especially for the dinosaur technologies that are wreaking havoc on our environment, from mountaintop coal removal (and stream destruction) to deep water oil drilling.
6. Phase out the mortgage interest deduction

This subsidy was a part of the housing bubble that was a part of the systemic financial system disruption that cause the Great Recession. It benefits the wealthiest taxpayers the most. It’s time to phase it out and quit using the code to support real estate developers and construction companies.

7. Increase rates for estate returns back to 2001 levels (maybe with a $2M exemption).

I’ve written about this many times before. In an age of growing inequality, the estate tax is one way to tamper down the power and wealth of the superrich. We should let the 2001 law return, at most with a slightly increased exemption amount.

8. Increase the number of rate brackets by at least 2 or three levels, so that CEOs making $700 million pay about 55%

Base broadening is all fine and good, but the fact is that the compensation to those at the top–whether salaries of CEOs making 400 times their average worker (compared to less than 30 times their average worker in the 1970s) or capital income to those with substantial financial assets–is so high that a return to the higher tax rates that existed before the 1986 tax reforms could serve an important stabilizing function. Democracy has trouble existing in a context ripe for oligarchy/plutocracy.

9. Enact partnership reform so private equity/hedge fund managers and others who earn a “profits” interest for services are taxed on that income at ordinary rates

When a service partner gets paid for services and is able to claim capital gains rates (as well as deferral), something is wrong. Let’s fix it. Service partners who get profits interests should be treated as receiving only ordinary income distributive shares on those profits interests.

10. Rethink corporate restructurings. Maybe we should enact a continuity of interest provision for reorgs that requires 80% continuing shareholders to qualify for reorg treatment—except for truly divisive spins (ie spins that do not include the acquisition of either controlled or distributing in a related transaction).

This relates to the first point. Given the power of corporations and their managers and shareholders and the systemic risk caused by monster industries (think—investment banks, car manufacturers, oil companies) that are no longer capable of flexibly responding to changed economic contexts, it is possible that the tax code should encourage the development of smaller, more entrepreneurial firms, rather than relying on the “economies of scale” notions that have underlain permitting corporate consolidations on a tax-free basis.