3 myths about tax reform

Rick Newman
Senior Columnist

There’s no tax-reform bill in Washington yet, but there’s plenty of confusion already about what might be in it, once it arrives—and what “tax reform” even means in the first place. Yahoo Finance recently asked economist Douglas Holtz-Eakin of the American Action Forum and a former head of the Congressional Budget Office, to deconstruct three myths involving tax reform prevalent in media coverage and commentary on the issue.

Myth: All tax reform is the same.

Not even close. “There’s a big difference between tax reform—something permanent and structural in nature, which transforms the economy—versus tax cuts, which is just less revenue,” Holtz-Eakin tells Yahoo Finance in the video above. Tax cuts can stimulate the economy temporarily, by pumping up take-home pay and giving workers more money to spend. But that only really makes sense during a downturn, when the economy needs a jump-start. The US economy is relatively strong right now and doesn’t need a short-term boost.

Tax reform, by contrast, can generate enduring economic benefits if it makes the economy more efficient or encourages more productive activity. “The kinds of things they’re talking about now are let’s get people to save more, invest more, expand the productive capacity of the economy, do it on a permanent basis,” Holtz-Eakin says. One example: lowering the corporate tax rate to a level closer to the rate in other developed countries to discourage American firms from stashing cash abroad and spur more foreign firms to do business in the United States.

Myth: We should just mimic the Reagan tax cuts of 1986.

Nope, we shouldn’t. Lost amid glossy memories of the booming Reagan economy are some key aspects of the big tax bill Reagan signed in 1986. That bill did simplify the tax code and cut tax rates for both individuals and corporations. But businesses ended up with a higher tax bill overall, due to the elimination of certain tax breaks. “The Tax Reform Act of 1986 was a tax increase on corporations used to finance large marginal rate cuts on individuals,” Holtz-Eakin wrote in a recent newsletter. “It put the United States at odds with global norms and is the main reason that reform is so necessary in 2017.”

Perhaps the most broken part of the tax code today is on the corporate side, given that the US corporate rate of 35% is the highest among developed countries—Yet few American companies pay at that rate, thanks to a slew of loopholes. Big multinationals have tremendous freedom to move money around the world and take advantage of various tax dodges and rate schemes. Applying the methods of 1986 won’t fix that.

Myth: Effective tax reform should get people to spend more.

Nope. Spending sparks short-term demand for goods and services, but it doesn’t necessarily make the economy more productive. What’s better? Creating new incentives to save, which increases investment and can improve productivity, along with eliminating loopholes that favor one type of business over another. Congress may accomplish some of that this time around, but there are special interest groups in Washington that benefit from every carve-out in the tax code and are sure to fight aggressively to keep them. That’s why the last meaningful tax reform was more than 30 years ago.

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Rick Newman is the author of four books, including Rebounders: How Winners Pivot from Setback to Success. Follow him on Twitter: @rickjnewman