Charting a Future for Welfare and Taxation

One of the biggest problems with the state of policy discussion in America right now is the lack of appetite for fundamental reform. I think there are a lot of reasons for this, but one important factor is the Trump administration's policy ignorance and disdain for evidence-based analysis. Rather than considering fundamental tax reform and welfare overhaul, the Trump administration has chosen instead to indulge in simplistic tax cuts under the banner of "reform." These Bush/Reagan-esque tax cuts that have been shown time and again to be fiscally irresponsible and negligible for economic growth. In addition, they don't rectify the underlying problems with the complexity of the tax code. Instead, they just lower rates for their wealthy constituents. While some manifestations of these "reforms" scrap deductions and change exemptions, these measures are typically milquetose and incremental, and still work within a broken system. While Paul Ryan and Kevin Brady still support corporate tax reform through the destination-based cash flow tax, opposition from retailers, automakers, and the Chamber of Commerce seem destined to kill the idea. The proposal itself seems wrongheaded in many respects. Namely, it's unclear that the dollar would strengthen adequately to stave off higher consumer prices. Stranegly, the proposal was also given priority over more sensible and studied reform proposals, such as a VAT or partnership model for corporate taxation.

As such, it seems unlikely that the complexities of the corporate and personal income taxes will be ameliorated any time soon. Nonetheless, Democrats would do well to consider fundamental reform as a counter to the Trump administration's half-measures, namely through a simplified tax code and welfare system that would jointly cohere to boost revenue, lower complexity, and increase transparency.

The first measures Democrats should endorse are a VAT in place of corporate taxation, and a personal income tax with no deductions or exemptions. Implementing a VAT in place of the corporate income tax would solve three problems: the global disadvantage of U.S. companies, tax avoidance, and complexity. Right now, U.S. companies are required to pay the 35% corporate income tax on foreign profits. While they receive a tax credit for foreign taxes paid, they must still pay any remaining U.S. taxes owed after the credit is applied. Almost no other countries require this of their corporations, and the result is that U.S. multinationals are at a competitive disadvantage. Implementing a VAT would also make taxation almost entirely unavoidable. By taxing the final products themselves instead of profits, corporations would not be able to engage in transfer pricing to claim hefty tax deductions. They would also be unable to claim inflated depreciation allowances for capital goods that have sneaked into the tax code due to lobbying or administrative error. This is a real problem: between 2008 and 2012, 288 of the 500 biggest companies in the U.S paid $0 in corporate income taxes at least one year, and the effective tax rate is substantially lower than the statutory rate of 35%.

Changing to a VAT would also get rid of distortions in corporate decision-making: corporations would buy profitable capital, rather than whatever allows them to claim lucrative depreciation allowances. Finally, switching to a VAT would be extremely simple, in that one simple rate would be applied to all goods and services. The current corporate income tax's complexity arises from considering what counts as costs or investment that can be deducted. However, costs under a VAT are only considered to be the goods and services purchased for the sellable product. For example, if Walmart pays $30 dollars to buy a pair of shoes, and sells those shoes for $60, it only pays taxes on the $30 in excess of the original $30 in costs. Now, there are complexities that arise from investment under a VAT, but the general consensus is that a VAT is simpler than the current corporate income tax system.

The problems under the personal income tax arise chiefly from the distortionary impact of deductions, and the general complexity of the system. While certain deductions may be beneficial, such as the deductions for charitable giving, many deductions and credits cause people to over-purchase certain goods and services, distorting economic decision-making. For example, the mortgage-interest deduction likely contributes to excessive home-buying and borrowing. Removing these deductions would simplify the tax code and remove distortions.

Now, there are two main problems raised by these reforms. The first is the regressive nature of a VAT, as well as the regressive impact of removing exemptions and deductions. A VAT would raise consumer prices, which would disproportionately hurt the poor. Exemptions and deductions also phase out at higher incomes, and thus removing these would have an outsize impact on the poor and middle class.

As such, I will offer a few welfare reform proposals that address these issues. First, I would propose a universal basic income in place of the current welfare system. Guaranteeing a decent level of income would alleviate some of the stresses of higher consumer prices from a VAT, and replace the income assistance of exemptions and deductions.

A universal basic income would also address more fundamental problems with welfare in America. Welfare in the United States takes the form of many different programs, many given in-kind and tied to work requirements. From TANF to SNAP to Section 8 vouchers, welfare in the U.S. is incredibly convoluted, resulting in administrative costs, lower utilization, and inefficiencies. A universal basic income would be administratively simpler, and would get rid of inefficiencies resulting from in-kind transfers. UBI would also be more broadly utilized given its universal nature, resulting in welfare gains for the many Americans that slip through the cracks in our current system.

In order to pay for such a system, the personal income tax could be increased and new brackets added, resulting in a de facto phase out for the UBI. In addition, worries over work disincentives could be addressed by making the UBI adequately low in order to discourage free-loading. The Earned Income Tax Credit or wage subsidies could then be applied to encourage work. Furthermore, concerns over work disincentives from a UBI seem to be exaggerated.

Finally, concerns over lower charitable contributions could be addressed through a separate subsidy code to reward certain activities, such as having children, giving to charity, or saving for retirement. Certain important deductions and credits, such as for healthcare savings and the child care tax credit could be converted to subsidies. While this may seem to be a superfluous change, a subsidy code would be more transparent, resulting in broader usage. Increased transparency would also make the subsidies more salient, increasing their power to incentivize positive behavior.

Now, I'm obviously simplifying many of these issues. My broader point in outlining some reform options is to illustrate the vast potential for improvements in our tax and welfare systems. Instead, the political discussion has ossified thanks to Trumpian demagoguery and general complacency in our political system. I would encourage those on both sides of the aisle to expand their ambitions for fiscal reform given the desperate need. Our tax code and welfare system are wickedly complex, inefficient, and distortionary, and we need politicians that are willing to engage in  visionary reform that addresses these problems.