Steering Clear of Sacred Cows and Hype

The dictionary defines a “conundrum” as “a question or problem having only a conjectural answer.” The word is perfect for describing the dynamics of the flat tax debate, because nobody can predict what the tax’s effect would be. The tug and pull between what is and is not known will make passage of tax reform very difficult, particularly since sacred cows such as home mortgage deductions are being threatened.

The dynamics of this tug and pull were evident during the last federal issues committee meeting of the Valley Industry and Commerce Assn. (VICA), a nonpartisan business activist group, as members attempted to develop a flat tax position paper.

On one level, the committee thought a flat tax could help the economy, make tax law compliance simpler, help level the playing field with foreign competitors and reduce the influence of lobbyists. However, on a visceral level, members have mortgages and do not relish the idea that people who live off interest and capital gains pay no taxes.

Most people react to tax debate according to how they will be affected in the short term. So those who have a stake in the status quo, who want to use tax reform to clobber political opponents, or who just want to create good media stories have the tools to stop meaningful tax reform. All they have to do is press the hot buttons.

If significant tax reform is to become reality, sacred cows will be affected. Some people will benefit more than others. There will be winners and losers. However, it is doubtful that there will be significant tax reform if the long-term advantages are not made clear and if the public only focuses on what is wrong with any particular proposal.

A good example of this dynamic is the real estate industry’s general reaction to the flat tax. Without considering possible transition proposals, the industry is decrying the possibility of an estimated 15% loss on real estate values because of loss of mortgage deductions. Although proponents acknowledge that short-term losses are probable, they believe the long-term effect on real estate will be positive because motivation to buy or sell will be based on economics, not taxation.

Doomsayers of the real estate industry forget that tax-motivated buying and selling was the source of its current malaise. During the ‘80s, prices increased because buyers had the “Oh well, it’s deductible” mind-set. Fortunes were made as prices kept rising, but eventually the bubble burst. Getting rid of tax incentives would return the industry to the efficiency of market forces.

Proponents also believe that interest rates will be reduced because banks will have more money to lend. They suggest transition steps that would allow people to keep their mortgage deductions until they refinance. The decision to refinance would be based on mathematics and would boil down to a comparison between keeping an existing mortgage with the tax deduction or refinancing without it. This option would soften the blow to real estate, yet it is being ignored because the focus is on what is wrong instead of what is right.

Current tax reform legislation is designed to stimulate savings, which will increase investment, which in turn will increase productivity. But productivity often means a loss of jobs as technology displaces labor. Economists argue that productivity means more jobs, not fewer. But if productivity actually eliminated jobs, why would we want to be more productive? The answer is that we are in a global economy. If we are not productive, we will lose jobs to global competitors. As we become more competitive through expanding our markets, we will create more and better jobs. This in turn will mean higher income for Americans and will help solve social maladies.

Sens. Sam Nunn (D-Ga.) and Pete V. Domenici (R-N.M.) have submitted a bipartisan bill to level the playing field internationally and to handle fairness and mortgage deduction issues. Under their Unlimited Savings Allowance Tax Act--or USA Tax--businesses would be able to deduct all their capital expenditures and would be subject to a low flat tax. From gross sales they would be able to deduct sales generated by exports and would be taxed for imports. Our European and Japanese competitors now do essentially the same thing. Rectifying this inequity would do more to help American innovators compete than current flat tax proposals.

The USA Tax proposal would tax individuals on their total income, including wages, interest and sales of capital assets, but income used for savings would be deductible. The tax would be progressive, not flat. Mortgage deductions would be allowed and individuals could deduct FICA taxes they paid. Few people have heard of the Nunn / Domenici proposal and probably will not if debate centers on the flat tax instead of tax reform. If we continue to focus on what we don’t want instead of what we do want, the chances of significant reform are remote.

The debate has to be changed.

VICA decided to identify what it wants tax reform to accomplish by setting specific goals, such as encouraging savings, facilitating global competitiveness and simplifying compliance. The approach will help members avoid getting caught up in media hype and political demagoguery while balancing individual considerations with business goals. If more people followed this path, we might, just might, get the kind of tax reform that strengthens our country and rekindles the American dream.