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Reform Taxes to Spur Economic Growth and Create Jobs

Nothing is paralyzing the U.S. economy as much as the unsettled question of taxes.

Taxation is a chief cause of the uncertainty that is stalling business expansion, capital investment, and—most important—job creation. A lineup of new tax increases looms. Then there is the stifling, cronyist tax code that is littered with politically motivated credits, deductions, and exemptions that only serve to further inhibit economic growth. All of this drags down an already stagnant economy.

To make matters worse, tax rates on individuals, families, businesses, investors, and entrepreneurs are too high. High taxes discourage work and investment, which leads to less take-home pay, fewer jobs, and slower overall economic growth—just what is largely missing from the economy today.

In order to fuel growth in the overall economy and provide more jobs and greater prosperity for ourselves and our children, America needs to overhaul its tax code to expand opportunity for all of those who want to work hard, earn, save, invest, and create wealth. To achieve this objective, we must hold down taxes and reform our needlessly complex, burdensome, and anti-growth tax system to sharpen incentives, level the playing field for all, and stop punishing saving and investment. This will ignite America’s economic powerhouse by re-energizing workers and entrepreneurs who are struggling to pursue opportunity and build a better and more secure future.

Unfortunately, despite the weak condition of the economy and the terrible burden America’s tax system puts on its economy, misguided proposals to raise taxes remain the centerpiece of President Obama’s economic agenda. Congress should not yield to his economy-damaging approach and should make the case that tax reform is vital to economic recovery.


Guiding Principles

  • Taxes are necessary to fund the legitimate operations of government. The core functions of government, such as providing for the common defens and upholding the rule of law, cost money, and taxes exist to raise revenues to fund these legitimate activities. Thus, Alexander Hamilton, in Federalist No. 30, recognizes the taxing power as “as an indispensable ingredient in every constitution.”
  • Taxes are not a tool to achieve a “fairer redistribution of income.” The point of our tax system is not to “level the playing field” by redistributing money from one group to another. To be clear, at issue here is not whether all should pay the same amount of taxes. Even under a flat tax system like the one supported by Heritage in our Saving the American Dream plan, the wealthiest Americans would still bear the heaviest share of the fiscal burden. No one is arguing that all should pay the same amount of taxes or denying that the wealthy bear a heavier burden. But it is clear that using the tax code to spread the wealth around is unfair and leads to disastrous economic results and leaves us all worse off in the long run.
  • The tax system should be simple and growth-oriented, with the same low rate for all and as few deductions as possible. Millions of people making decisions about their own lives yields better social and economic outcomes for everyone than a few politicians trying to engineer everyone else’s lives. The tax code should not drive the economic decisions of families, businesses, investors, and entrepreneurs with special-interest tax preferences that breed cronyism. The proliferation of exemptions creates irresistible incentives for big players to rig the tax code in their favor at the expense of smaller players and the common good of the country. Ultimately, tax reform would result in a simplified tax system with a low, flat rate that would increase the incentives for engaging in the productive activities that generate economic growth and jobs and deal a serious blow to cronyism. Nobody should need to hire high-priced lawyers and accountants or spend hundreds of hours each year just to file federal income tax returns.
  • Don’t tax income more than once. Double taxation—like capital gains taxes, dividends taxes, and the death tax, all of which apply to income that has already been taxed—is unfair. It also increases the tax code’s distortion of economic activity and slows growth. Eliminating double taxation is the right thing to do. Likewise, the U.S. is the only developed country that taxes its businesses on the income they earn after they have already paid taxes on it in other countries. That hurts our competitiveness and needs to change.
  • Higher taxes weaken the economy. The healthiest and most powerful force for near-term deficit reduction is a strong economy generating more revenues organically, but higher taxes are almost sure to blunt economic growth. In fact, recent evidence strongly accords with intuition that higher taxes and higher tax rates impede economic growth, while lower taxes and lower tax rates encourage economic growth. In 1993, for example, President Clinton ushered through a major tax hike just as the economic recovery was gaining steam. The result was a period of subpar growth. Then, in 1997, Republicans in Congress pushed through a tax cut, and the famous late-1990s economic boom was launched. Again, in 2003, Congress accelerated the Bush tax cuts, enacted in 2001 but initially phased in over many years, and added substantial reductions of the tax barriers to saving and investment. The result was a marked and nearly instant acceleration of the economy and a rapid, sustained reduction in the unemployment rate. And a stronger economy means a larger pie for all Americans. It means higher take-home pay, lower unemployment, and higher tax revenue—without the job-killing tax hikes on small businesses or investors.
  • Tax reform should boost the economy, not raise taxes. The purpose of tax reform is to reduce the role of government in market decisions to encourage dynamism and growth in the economy. It is not to raise more revenue for Washington to spend. Eliminating tax preferences while failing to lower rates in a way that fully offsets the increased revenue from eliminating those preferences—or, worse, raising rates at the same time—is not tax reform. It is raising taxes.

The Way Forward

  • Reject tax increases. The fiscal mess we are in today is the result not of too little taxing, but of way too much spending. We must get a handle on our reckless spending instead of encouraging the growth of government by increasing taxes. America needs job-creating economic growth, and increasing taxes will hurt, not help, the effort to achieve this important goal. Policymakers should reject any suggestion of higher taxes. Higher taxes—whether from raising tax rates or from eliminating tax preferences without accompanying pro-growth changes like lowering rates—are unacceptable.
  • End the death tax. The estate tax—better known as the death tax—contradicts one of the central promises of the American Dream: the promise that if you work hard, save, and live prudently, you will be assured the enjoyment of your earned success and can leave the fruits of your labor to your children. Taxing a lifetime of savings, on which Americans have already paid taxes when they earned it, is reprehensible. The death tax also takes a toll on the economy as it amounts to a tax on capital that destroys jobs, slows growth, and lowers wages. It hits family-owned businesses hardest, as they rarely have enough liquid assets to pay an untimely estate tax bill. The death tax should be permanently repealed.
  • Pursue improvements in the tax code. Today’s enormously complex and increasingly burdensome tax system must be seriously reformed to eliminate its countless unfair loopholes and unleash the productive potential of the U.S. economy. Congress must therefore make the popular case for tax reform by explaining to the American people what is wrong with the tax code and how tax reform benefits all Americans—not just the wealthy. The congressional committees most important for tax reform, the House Ways and Means Committee and the Senate Finance Committee, have held hearings on tax reform over the past year. They must hold more such hearings with greater regularity to educate Members of Congress and the public about the details of tax reform, and they should pass fundamental tax reform packages to demonstrate how they would change the tax code.
  • Congress can make even greater strides toward tax reform by showing how it could help the economy and workers by eliminating the tax preferences that do the most economic harm and constitute the most egregious cases of cronyism in the tax code. For instance, preferences for certain types of energy production and use, or for the purchase of certain so-called energy-efficient products, create distortions in the market that give some industries an unfair edge over the competition. Congress should eliminate these policies and offset the revenue increase that would result with pro-growth changes in taxes: for example, lowering marginal tax rates or making it easier to save without tax consequences. These would be “mini tax reforms” that would help pave the way for the full-scale version of reform down the road.
  • Lower the corporate income tax rate. The U.S. has the highest corporate income tax rate in the industrialized world: almost 40 percent when combining the federal rate with the average rate added by the states, making it the least competitive developed country for businesses that wish to make new investments and create jobs. To revive the competitiveness of U.S. businesses in the global marketplace, the rate must come down to the average of other industrialized countries. The U.S. corporate tax rate should be set at (or ideally below) the Organisation for Economic Co-operation and Development average of 25 percent to eliminate the incentive to locate businesses and jobs overseas instead of in the U.S. Congress should seize on bipartisan agreement about the need for corporate tax reform and put together a plan that lowers the rate below the OECD average.
  • Be fair to small businesses. Small businesses usually pay taxes through their owners’ individual tax returns. This generally subjects them to the high rates their owners pay, which were increased in January 2013. As part of corporate tax reform, Congress should change how it taxes small businesses so that they pay at the entity level and set the top small-business rate equal to the new, lower top corporate rate. A lower rate for small businesses would have the added benefit of encouraging growth by sharply increasing their incentives to invest and take on the kinds of risk that can pay off and lead to new jobs.
  • Shift to a territorial tax system. Should Congress take up corporate tax reform, it would also be wise to switch to a “territorial system” that taxes businesses only on the income earned within U.S. borders. This would improve U.S. competitiveness abroad and in turn spur job creation. It would represent a move away from the so-called worldwide system the U.S. has now. A territorial system is in line with the tax policies of America’s economic competitors and is neutral to investment. The current worldwide system discourages investment that would create jobs here in the U.S. because it adds a second layer of taxation that businesses’ foreign competitors do not face. Eliminating this extra tax would put U.S. businesses on an equal footing with their foreign counterparts.
  • Eliminate the alternative minimum tax. The alternative minimum tax (AMT) is a complicated secondary income tax system originally designed to raise taxes on higher-income earners by taking away certain deductions. Because Congress never indexed its income threshold to grow with inflation, the AMT now threatens to ensnare millions of middle-income families. Eliminating the AMT would reduce complexity and prevent unintended tax hikes on the middle class.
  • Build on existing work. As it works toward tax reform in the future, Congress should keep in mind that a reformed tax code should accomplish all of the goals listed above and apply a dramatically lower and flat rate to a proper tax base that is not eroded by an overabundance of exemptions, credits, and deductions. There are numerous existing tax reform plans from a variety of sources, so Congress need not start from scratch. The Heritage Foundation has crafted such a plan as part of its comprehensive fiscal plan Saving the American Dream. It minimizes deductions and tax credits and establishes a single rate (between 25 percent and 28 percent) on income that is not saved; removes caps on how much money can be saved for retirement; and eliminates payroll taxes, the AMT, nearly all excise taxes, capital gains taxes, dividends taxes, and the death tax. As a result, it is revenue-neutral. Policymakers should follow this model as a guide for tax reform.