Regarding President Trump’s new tax reform/tax cut guidelines, Congress should insist on maintaining a centerpiece of President Reagan’s monumental Tax Reform Act of 1986; namely, taxing all sources of income at the same rates as ordinary income like wages. Whereas Mr. Trump has suggested special, low tax rates on so-called "small business income," dividends, and capital gains, there is a strong rationale for keeping tax rate parity on varying sources of income.
Affordability is at the top of the list of reasons not to lower tax rates on special classes of income. Our nation cannot afford a massive tax reduction that increases the national debt. Increases in economic activity from tax reductions are highly unlikely to generate enough offsetting tax revenues. How much longer can we and should we continue relying on foreign governments to purchase our debt instruments so we can have a tax cut?
Fairness is always important when considering tax reforms. Arguably it is inherently unfair that under the proposed tax guidelines, most ordinary wage-earning taxpayers would be subsidizing other taxpayers who would receive lower rates on small business income, dividends, and capital gains. In fact, numerous so-called “small businesses” are in reality huge corporations and partnerships that serve merely as investment and tax vehicles for their owners.
Despite some arguments to the contrary, lower rates on small business income, dividends, and capital gains are not required to give individuals an incentive to invest in new businesses. Under Reagan’s 1986 tax act, new business investments did not come to a halt even though Reagan and Congress deliberately chose not to provide special low tax treatment on differing sources of income. During my career in public accounting, I cannot remember a single client that ever made a decision to invest or not invest in a business or individual stock just based on having low tax rates on dividends or capital gains.
A goal of tax simplification gives way to tax “gamesmanship.” For example, under current law many individuals create corporate entities to receive their consulting income, which is similar in many respects to wage income. Why should consulting income be taxed at lower rates than normal wage income merely because it might be classified as “small business income”? Small business income received through so-called “S Corporations” and partnerships already receives favorable tax treatment since the income is taxed at the individual level and not taxed first at the corporate or partnership level. Any “double taxation” already is avoided under current law.
Reinventing the wheel on tax reform can be avoided if the same tax rates are applied to small business income, dividends, and capital gains. Reagan and Congress already provided a good blueprint with the research, thought, and compromise that accompanied passage of the Tax Reform Act of 1986.
Any tax reform should result in a fair tax system for all Americans. Don't we want a fair tax structure as well as a new one? President Reagan did when he signed his signature 1986 tax reform act.