The US Economy Needs President Trump's Tax Reforms

March 3, 2017

In his speech this week to a joint session of Congress, President Trump promised Americans his economic team is putting together “historic tax reform” that “will reduce the tax rate on our companies so they can compete and thrive anywhere and with anyone" and "will provide massive tax relief for the middle class.” Treasury Secretary Steven Mnuchin elaborated further in a statement released after the speech, stating, “We must simplify the tax code, reduce business tax rates, and make America competitive in the global economy.”

Hope runs high that the Trump team will adopt the principles laid out in a blueprint put forward by House Speaker Paul Ryan and House Ways and Means Committee Chairman Kevin Brady. It is a pro-growth prescription for increasing investment, creating jobs, capturing lost revenue, encouraging companies to remain on US soil, and enhancing America’s global competitive edge.

The Dow Jones Industrial Average, Standard & Poor’s 500 Index, and the Nasdaq all responded to the president’s speech with enthusiasm. The Dow rose above 21,000 for the first time. Enthusiasm is no surprise, considering that the US tax code hasn’t been revamped in more than 30 years, and now imposes the highest statutory corporate tax rate (combining state and federal, 39 percent) among G-8 countries, and the second highest marginal effective rate. High corporate taxes not only discourage growth domestically, they also hamper US firms that compete with foreign counterparts, who pay a global average top statutory tax rate of 22.5 percent (on a steady decline from a 2003 high of 33 percent).

As Doug Holtz-Eakin, president of the American Action Forum, recently declared: “Currently, corporation tax is the most anti-growth tax you can find in literature. It hurts our capacity to grow and compete internationally.” Consequently, the quest for reform tops the American business agenda. Reform is equally critical for millions of individuals who rely upon private business firms for their jobs, whether they know it or not.

The Ryan-Brady plan, known as A Better Way, is exactly the comprehensive approach that leaders from both political parties should embrace. It transforms the complicated corporate tax into a simplified “cash flow” tax at a flat 20 percent rate; caps the rate on “pass-through” entities at 25 percent; denies interest deductions but allows full and immediate expensing for 100 percent of capital expenditures; imposes 6, 12.5, and 16.5 percent taxes respectively, on dividends, interest, and capital gains paid to households; and adopts a territorial system for taxing profits earned abroad (bringing America in line with the rest of the world).

Importantly, if controversially, the Ryan-Brady plan also introduces border adjustment. This feature of the plan would impose the new cash flow tax on imported goods and services, while exempting exported goods and services. Without border adjustment, some companies might—for tax reasons alone—shift their production to lower tax countries abroad, and import goods and services to the US market. As Holtz-Eakin explains, the “main virtue” of border adjustment is to “protect the integrity of the US tax base… [by removing] all incentives to transfer projects to outside the United States and bring [the products] in tax free.” As an additional benefit, border adjustment would serve to level the playing field with global trading partners—such as Canada, China, Mexico, and European member states—that all apply similar adjustments to their value-added tax (VAT) systems.

To be sure, many firms oppose border adjustment, fearing higher prices at retail check-out counters. Arguments for and against it will flood the media in the months ahead. But the border adjustment debate should not obscure the core goals of long-awaiting business tax reform: slashing the uncompetitive US tax rate on business firms and joining the rest of the world with a territorial tax system.

The Tax Foundation has studied the bold reforms found within the Ryan-Brady plan and concluded they would “raise American GDP by 9.1 percent in the long run, lift wages by 7.7 percent and add some 1.7 million jobs.” These reforms represent a core foundation to deliver on the president’s oft-expressed promises to fix the economy, create jobs, and strengthen American businesses competing in the global marketplace.

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Gary Clyde Hufbauer Senior Research Staff