There’s Plenty of Hope for Tax Reform

Published March 3, 2017

Wall Street Journal

J.P. Morgan chief James Dimon said this week that tax reform is doomed, at least for this year. Last week Sen. Tom Cotton, an Arkansas Republican, took to the Senate floor to attack a pillar of House Speaker Paul Ryan’s tax reform plan, the border-adjustment tax, as “stupid.” Politico described the House tax reform’s prospects as “ominous.”

To which Ronald Reagan might have said, “Well, there you go again.”

Tax-reform plans are always attacked viciously at first. When the president ultimately signs the bill, however, those who once declared it “dead on arrival” often end up next to him on the platform, trying to score a pen. It is tough for Republicans to vote against a plan that helps both labor and capital—or, as Nobel economics laureate Theodore Schultz called them, “human and nonhuman capital.”

We were involved in the successful 1981 and 1986 tax-reform efforts. In both cases, designing tax policy was not pretty. Elbows flew. Yet in both instances, the pessimistic conventional wisdom proved incorrect.

Consider how events unfolded. In the year leading up to the enactment of the 1981 Reagan tax program, GOP tax-policy makers, like today, were at each other’s throats. President Reagan and Rep. Jack Kemp (R., N.Y.) presented the outward image of a close father-son team. Actually, on tax policy, Kemp was a constant thorn in Reagan’s side.

As for 1986, people forget that tax reform came about as a kind of fluke. GOP negotiators shrewdly took advantage of what seemed initially a disastrous development. In the two years leading up to its enactment, the conventional wisdom was that tax reform was dead. On Capitol Hill, a House controlled by Democrats and a Senate controlled by Republicans, each with intraparty divisions, had reached a stalemate on tax reform. But something unexpected happened that turned out to be a positive catalytic force.

At the time, former Merrill Lynch chairman Donald Regan was Reagan’s (sometimes politically deaf) Treasury secretary. At Treasury a group of mostly nonpolitical tax strategists cobbled together a radical tax-reform plan that skewered special interests and reduced the top personal income-tax rate to 35% from 50%.

Both the corporate lobbying community and the Reagan White House were furious. Adding to the confusion, around that time White House Chief of Staff James Baker and Regan switched jobs. It was now Mr. Baker’s responsibility as Treasury secretary to sell Regan’s controversial plan.

Sounds like a recipe for disaster. It wasn’t. Republican tax strategists used the new radical plan as a wedge to break the ideological and partisan logjam. After a fair amount of jockeying for position, a bipartisan group of congressional tax writers hammered out a compromise, which knocked off the Regan plan’s rough edges, cut the top tax rate to 28% from 50%, and taxed investment income the same as wages (eliminating what some now call the “Warren Buffett’s Secretary Problem”—taxing Main Street at much higher rates than Wall Street).

If history is any guide, it would be wise for the pessimists to hold off on signing tax reform’s death notice. That’s because Republicans risk dire consequences if they don’t achieve the promised 3% to 4% economic growth by fall 2018.

It is unlikely that deregulation alone can accomplish this goal. The huge gains in the U.S. stock market since the election are based largely on investors’ anticipation that bold tax reform is coming—and soon. If the GOP can’t deliver on tax reform, ObamaCare replacement and economic growth, there’s the real definition of “stupid.”

True, the border-adjustment tax is complicated. The proposal, which would eliminate the corporate income tax and place a 20% tax on imports, assumes that a stronger dollar will counter any effect of rising consumer prices. Executives of Wal-Mart and other retailers hate the tax because of the risk that the cost of imports could rise. But if you don’t have a job, you can’t buy much. And no one denies that the structure of the U.S. corporate tax code has put American companies at a global disadvantage.

The border-adjustment tax has its pros and cons. One downside is that the world could retaliate if the U.S. taxes imports. Its upside is that the new tax would allow the broader rate-cutting tax-reform package to be revenue neutral, like the successful 1986 reform.

The border-adjustment tax would raise more than $1 trillion in revenue over 10 years, according to the Tax Foundation. If rejected, what will replace it to assure revenue neutrality? Without a substitute, any incentive from cutting marginal income-tax rates would be tiny. And remember, there is no free lunch if the Republican Congress and the administration expand the deficit. Because the current account balance equals the excess of national saving over investment, a tax-reform stimulus that busts the budget deficit would make the president’s promise to reduce the trade deficit impossible.

Successful tax reform often begins with a catalyst, even a controversial one, which stirs up debate and brings the relevant parties to the table. House Republicans should insist on the border-adjustment tax until opponents offer an acceptable alternative. In Washington, rhetoric is cheap, but a plan beats no plan. And a continuation of the tax status quo would be bad news for congressional Republicans, the Trump administration and Main Street.

Mr. Smick, the author of “The Great Equalizer: How Main Street Capitalism Can Create an Economy for Everyone” (PublicAffairs, 2017), was Rep. Jack Kemp’s chief of staff from 1979-84. Mr. Mueller, a fellow at the Ethics and Public Policy Center in Washington, D.C., was Kemp’s staff economist from 1979-88.

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