Don't mix tax cuts into tax reform

Tax reform is in the air.

Republicans now have the opportunity, through their legislative control and governors’ chairs, to propose alternatives to a tax system created in 1986 and patched and amended ever since.

In Washington, the talk about comprehensive tax reform is just that – talk – but some changes are possible.  Most of the focus appears to be on the corporate tax rate.

In theory, the federal tax on corporations is 35 percent, a rate higher than in many other industrialized countries.  In fact, loopholes and special interest features lower the effective rate for large corporations to a more competitive level of 12.6 percent.

One of the key purposes of tax reform is to make rates fairer without raising revenues.  That should mean that if the federal rate is cut, some loopholes ought to be closed.

But, if the objective is to reduce government revenues or boost to corporations, the Republican proposal may be limited to cutting the rate.  That could give rise to a battle between President Obama, who would accept corporate tax changes, and the GOP-dominated Congress.

One other area in the corporate tax system is ripe for change.  Right now, corporations find it attractive to move their headquarters abroad, often more in theory than in terms of actual operations, but allowing them to avoid U.S. taxes.  That could be fixed by law with some bipartisan effort.

The federal “tax extender” law will once again have to be reviewed.  Usually left to the last minute and then not changed, this law contains a raft of tax breaks for various industries.  At this stage, it is difficult to know if Congress, taking advantage of a non-election year, will have the courage to cut some of these loopholes.

Finally, the Republicans can be expected to try to repeal the inheritance tax, which they call the “death tax.”  It is intended to make sure that the wealth of the wealthy, who may have evaded taxes, can finally be taxed.  The GOP is unlikely to succeed.

States often simply duplicate the federal tax system, though at lower rates.  But there is room for reform at the state level.

Maine provides a good example.  Gov. Paul LePage has made proposals that, in key respects, are more closely in line with past Democratic ideas than with his own GOP.  But he goes too far.

Maine’s top income tax rate of 7.95 percent is among the highest in the country.  LePage wants it cut to 5.75 percent, but would really like to see it go away entirely.  The cut makes sense; elimination does not.

The income tax requires those with higher incomes to pay higher rates than others down the income scale.  If it were eliminated, the burden would fall almost entirely on sales and property taxes that hit middle-income people more heavily than the wealthy.

A national study published this week supports the point that wealthier people pay a smaller portion of their income in state and local taxes than the rest of the people.

LePage sees the income tax as outmoded.  But government, even if slashed, costs money.  Roads and bridges urgently need repair.  Eliminating the income tax would make it more difficult to meet basic needs. 

To pay for his income tax reduction, LePage properly proposes sales tax increases.  Maine taxes fewer goods and services than most other states, and the governor would expand the list.  He would also raise the rate to 6.5 percent, keeping it well below rates in other states.

The principal obstacles are the need to limit the impact of the sales tax increase on lower-income people and resistance by businesses whose owners believe that the sales tax will keep customers away.

Yet, there is no evidence that sales taxes stifle sales.  Lawmakers need to ask themselves if they have ever refrained from making a purchase because of the tax.

LePage also wants to eliminate the estate tax, which mainly affects the wealthy.  While the federal inheritance tax should be retained, a good case can be made for ending its state counterpart.  The high income tax rate combined with the estate tax drive people from the state who otherwise could continue to contribute to its economy.

LePage’s proposals are not revenue neutral.  He wants to cut state taxes, so the burden would shift to the property tax and to hospitals, schools and other entities now tax-exempt.  By tying reasonable changes to controversial cuts, LePage endangers his own tax reform.

If the GOP will compromise and stick to real reform, this could be the year for change.