Roll a seven for a rational, pro-growth tax system

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Since April 15 fell on a Sunday, and the District of Columbia celebrates Emancipation Day on April 16, Americans didn’t have to file their income taxes this year until April 17. Don’t you feel lucky?

I don’t. As both a taxpayer and an economist, our tax system ranks as a bewildering, frustrating mess. Not only is too much money drained from the private sector, but the way taxes are imposed makes little sense. No one should be surprised, though, since tax policy is all about politics, not economics.

So, taxpayers truly would be lucky if our elected officials rolled a seven on tax policy. That is, if they implemented the following big seven changes.

1) Kill the Obama tax increases. President Barack Obama has back loaded a bevy of tax increases to take hold after the November elections. Those include higher personal income, capital gains, dividend, and death tax rates, which, if imposed, will hit entrepreneurs and investors hard, doing further damage to the economy and jobs.

2) Cut personal income tax rates. Given the grossly underperforming economic recovery, we need more than simply stopping scheduled tax increases. Pro-growth reform is needed to implement a lower, flatter income tax. The top personal income tax rate should be no more than 25 percent, which would enhance incentives for working and entrepreneurship. In fact, it would directly boost the bottom line of most businesses, given that 92.7 percent of U.S. businesses (based on the latest IRS data), since they are not C Corporations, pay the personal income tax, rather than the corporate income tax.

Of course, an explicit tax cut would increase the economic impact of such reform, but if revenue neutrality (i.e., neutral compared to expected revenue under the current tax system) is a goal, various tax deductions, credits and carve outs can be eliminated as tax rates come down.

3) Make the corporate income tax rate competitive. Of course, for millions of businesses, the corporate income tax still matters. And it matters for U.S. competitiveness in the global economy. Currently, the combined U.S. federal and state corporate income tax rate stands out as the highest among developed nations. We gained that dubious position at the start of April when Japan reduced its tax rate.

Also keep in mind, as part of a tax relief plan, Great Britain is reducing both its personal and corporate income tax rates. The corporate rate went from 25 percent to 24 percent this month, and will drop to 22 percent in 2014. The U.S. needs to get its corporate tax rate — now at 35 percent at the federal level — down to where Great Britain is headed. Even better, Ireland has a 12.5 percent tax rate.

4) Kill capital gains taxes. The capital gains tax, arguably the dumbest levy from an economic growth perspective, quite simply reduces potential returns on entrepreneurship and investment. That means less risk taking and less growth. By killing off both individual and corporate capital gains taxes, investment in new and expanding businesses would be energized, and the U.S. would become a magnet for international capital.

5) Terminate the death tax. In 2001, a tax package was passed and signed into law that phased down and eventually eliminated the death tax. Indeed, there was no death tax in 2010. But it returned in 2011 with a top rate of 35 percent. This tax on the total assets of individuals, investors and business owners at death not only is unsavory and unfair after paying a lifetime of taxes, but is counterproductive in terms of building and investing in businesses. The death tax needs to die … again.

6) Expensing capital investment. Giving all businesses the option to expense capital expenditures (that is, to write off such spending in the year made) would be a positive incentive for investment in plant, machinery, technology and so on. Small businesses have a limited expensing option, but it should be extended to all businesses, providing the choice of expensing or using current depreciation schedules.

7) End withholding. Finally, why does the government take taxes out of people’s pay before they receive their earnings? Quite simply, it’s easier to impose and raise taxes through withholding, and that was the purpose when it was passed by Congress in 1943, and signed into law by its enthusiastic supporter, President Franklin D. Roosevelt. Too many people simply look at take-home pay, giving little attention to where the rest of their paychecks went.

Think about how views regarding the size of government and the level taxes would change if each person had to sit down and write a check to the government along with the rest of the monthly bills. Business owners, of course, already write quarterly checks to the government. If everyone had to do that, we’d see a much more engaged public on spending and taxing issues.

People too often get lost in the politics of taxes and spending. Politics, though, usually deals with elections, power and rhetoric. On the other hand, economics focuses on the actual effects of government policies, including taxes. If we had more economics and less politics when it comes to taxation, we truly would be one of the luckiest nations on the globe.

Raymond J. Keating is the chief economist for the Small Business & Entrepreneurship Council. His new book is “Chuck” vs. the Business World: Business Tips on TV.