Obama deficit panel may surprise on tax reform

November 2, 2010

President Barack Obama’s bipartisan deficit commission has a mandate to cut the U.S. budget gap. But the White House panel may surprise in another area: tax reform. Democrats and Republicans are taking a hard look at a plan that would simplify the code and cut corporate taxes. Although not perfect, it would be a big improvement.

Much of the public focus on the commission, which is expected to vote on any recommendations it makes next month, has been on its efforts to slash spending. Two areas that could suffer the knife are tax breaks and Social Security. But panelists are also assessing ways to reform America’s labyrinthine tax code to promote economic growth, and thereby more tax revenue to help pay down the debt.

Smartly, members won’t recommend a total scrapping of the current system in favor of some ideal tax code concocted by academics. No politically unfeasible value-added or flat taxes here. Instead, they’re examining a plan devised by politicians—Senator Ron Wyden, a Democrat from Oregon, and Senator Judd Gregg, a Republican from New Hampshire—that uses the current system as a baseline and then tweaks it.

The Wyden-Gregg idea mostly succeeds. For individuals, it would reduce the number of tax rates from six to three and dump the alternative minimum tax. It would also combine several existing government savings plans into one. For business, Wyden-Gregg would combine multiple rates, including a 35 percent top rate, into a flat, 24 percent corporate rate. Small businesses could immediately write off capital investments. And companies could only deduct part of their interest payments, making equity financing more competitive.

There are some downsides, which is to be expected of a plan meant to win votes on both sides of the aisle. It would raise the top capital gains tax rate to 23 percent from 15 percent. It would also subject the foreign income of U.S. multinationals to immediate taxation. Most advanced economies tax only income earned domestically.

But taken as a package, Wyden-Gregg would create a more pro-growth tax system without, says the Congressional Budget Office, adding to the national debt. Corporate taxes, for instance, are the most harmful tax that nations levy, according to the OECD. If Congress and the White House want to shock cynics with a big compromise in 2011, tax reform would a great place to start.

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