This week, Senators Ron Wyden (D-Ore.) and Dan Coats (R-Ind.) introduced S. 727, the "Bipartisan Tax Fairness and Simplification Act of 2011."  It has one key advantage–namely, lowering the corporate rate from 35 to 24 percent.  This is a big deal.

Unfortunately, the bill is riddled with many other problems, to the point that it has to rank among the most disappointing of these efforts we've seen.  Among the issues:

  • There's not yet a score from the Joint Committee on Taxation.  As a result, it's impossible to judge whether this bill is a net tax increase, a net tax cut, tax revenue-neutral, and according to what baseline.  Therefore, there are not any Pledge issues at all as of yet
  • The top personal rate remains at 35 percent.  A goal of fundamental tax reform should be to reduce that individual top rate, since that's the rate that a majority of small business profits pay taxes at.  This also creates a discontinuity between corporate and pass-through entity taxation
  • The effective marginal tax rate on capital gains and dividends would rise from 15 percent to 22.75 percent.  Even worse, the bill fails to rescind the Obamacare 3.8 percentage point surtax on investment income, meaning that the capital gains and dividends rate would rise all the way to 26.55 percent after 2013
  • IRS preparation of tax returns.  The bill provides for IRS preparation of tax returns for the first time.  This is a conflict of interest, since the IRS wants to maximize tax revenue paid.  They should not be in the position of determining tax liability for this reason.
  • Depreciation lives are slowed down, moving in the opposite direction of expensing.  Rather than move toward full and immediate expensing of business tangible property, the bill further slows down complicated and economically-inadequate depreciation lives
  • International income is exposed to double taxation.  On the personal side, this is achieved by the repeal of the foreign earned income exclusion.  On the corporate side, this is done by ending many international deferral rules and changing the corporate tax credit.  On the whole, the bill moves away from a territorial system (which is the goal of conservative tax reform) and toward full and unmitigated worldwide taxation.  In fairness, there is a one-year repatriation tax holiday, but that really doesn't make up for the permanent damage done on the individual side
  • Death tax of 45 percent.  Because the bill is silent on the trajectory of the death tax, it implicitly-endorses a death tax top rate of 45 percent with an exemption of $3.5 million.  In 2011, the death tax is only 35 percent with an exemption of $10 million for married couples.
  • Disproportionate targeting of energy consumers.  It seems that energy companies fare worst under the bill's base-broadening.  Among the elements hitting them directly are: the repeal of dual capacity rules, the repeal of percentage depletion, and Section 199 (domestic manufacturing deduction) repeal.  There are others, but these are the most damaging gross tax increases which could result in higher energy prices.

In sum, you have a bill which fails many conservative tests of fundamental tax reform.  It is a mixed bag on tax rates, is bad on investment income, bad on the death tax, bad on full business expensing, and bad on international taxation.  It's not clear that the country would be better off under this package, even it it were revenue-neutral.

A comprehensive tax reform package should have the following components:

  • Top personal and corporate rates no higher than 25 percent
  • Full business expensing replacing depreciation
  • Capital gains and dividends rate of 0 (also achieved through uncapped IRA-type accounts)
  • Moving toward a territorial international tax system (also achieved through permanent repatriation)
  • No death tax