Thursday, October 28, 2004

The recently enacted corporate tax bill has attracted a lot of criticism, but the legislation actually is rather impressive considering the political obstacles. All things considered, it’s a case of good, better, best.

Good: The legislation will force the European Union to eliminate more than $4 billion of taxes on American exports. Better: A substantial portion of the bill is devoted to much-needed tax reforms that will boost U.S. competitiveness. Best: These provisions represent another step on the road to a simple and fair flat tax.

One of the least appreciated aspects of the Bush presidency is that the tax cuts of the last four years have moved the United States toward genuine tax reform, as can be seen by reviewing two of the most important principles of the flat tax: First, there should be just one tax rate and it should be very low. This ensures fairness by treating everyone equally, and it promotes growth by minimizing the tax burden on productive behavior. Second, no income should be taxed more than once. This feature eliminates the bias against saving and investment and ends the double-taxation of income earned outside U.S. borders.

Based on these two principles, the Bush tax cuts deserve high grades. The 2001 tax cut, for instance, lowered tax rates and began the process of repealing one of the worst examples of double-taxation, the death tax. The 2002 tax cut lowered the “depreciation” tax penalty on new investment. The 2003 tax cut accelerated tax rate reductions and substantially lessened the double taxation of dividends and capital gains. Last, but not least, the 2004 corporate tax bill reduced the double-taxation of income earned in other nations.

All of these changes have moved the United States closer to a flat tax. Critics will argue that other tax reform principles — such as simplicity — have not been achieved. This is a fair complaint: Indeed, it’s possible that the tax code is even more complicated than it was four years ago. That is why President Bush’s endorsement of a tax-reform commission is such encouraging news. A complete rewrite of the tax law would create an opportunity to sweep away the junk cluttering the internal revenue code.

This will require politicians to stop using the tax code as a tool to pick winners and losers. Decades of social engineering and backdoor industrial policy have resulted in needless complexity. Even when lawmakers approve good legislation, they cannot resist the temptation to insert special-interest provisions. The 2004 corporate tax bill is a good example. This legislation included some very important reforms to boost U.S. competitiveness, including:

{bulletReducing the double-taxation of foreign-source income so American companies are more competitive in global markets.

{bulletSuspending a tax penalty that discourages American companies from investing overseas profits in the United States.

• Lowering the tax rate on U.S. manufacturing.

• Putting an end to punitive European taxes on U.S. exports.

Unfortunately, these good provisions are somewhat tarnished since supporters had to add some pork to the bill to attract votes. This is why the bill included a new deduction for state sales taxes, a subsidy for bigger state budgets and a step away from tax reform. Other vote-seeking provisions benefited specific companies or industries, though it is worth noting that some of these items actually are good tax policy.

The campaign for good tax policy is further complicated by arcane budget rules and antiquated revenue-estimating procedures. This is why there is a complicated and less-than-ideal reduction in the manufacturing tax burden rather than a much more desirable across-the-board reduction in the corporate tax rate.

Given all the constraints, it is sometimes amazing that the political process ever produces any good tax legislation. This is why it is important to consider the big picture. None of Mr. Bush’s tax cuts have been perfect, either as first proposed or as ultimately enacted. But each one has taken the United States in the right direction. Added together, we are much closer to a flat tax.

Would it be better for the United States if the president and Congress had gone with a flat tax instead of enacting four different tax bills in the last four years? Of course, but the perfect should not be the enemy of the good. Like sausage-making, the legislative process isn’t a pretty sight. But we shouldn’t complain too loudly if the net result is a better tax code and a more competitive United States.

Daniel J. Mitchell is the McKenna fellow in political economy at the Heritage Foundation.

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