By Jack Kemp
February 25, 2003 for Townhall.com
In 1981, Congress enacted the Kemp-Roth 25-percent-across-the-board tax rate reductions (aka the Reagan tax cuts), which made a significant improvement to the tax code and helped free the economy from “stagflation” (simultaneously rising inflation and unemployment). The top tax rate was then 70 percent, and the lowest rate was 20 percent.
These tax rate reductions, however, addressed only half of the problem with the tax code because they left the ill-defined tax base – the ill-conceived definition of what constitutes taxable income – largely untouched. Thus, the federal income tax code continued to favor consumption and debt by double- and triple-taxing saving and investment, and it still contained a bewildering array of ad hoc exceptions, deductions, exemptions and preferences – so-called “tax loopholes.”
Despite the derogatory label, the major loopholes had been put in the tax code over the years in an attempt to mitigate some of the perverse incentives and economic damage created by the erroneous definition of taxable income. As well-intentioned as this haphazard weave of special tax provisions may have been, it failed to ameliorate the economic damage of a mis-specified tax base, and it frequently increased economic distortion, making matters worse – on top of which it made the tax code incomprehensibly complicated and manifestly unfair and corrupted the decision-making and behavior of businesses and entrepreneurs.
In 1986, Congress attempted to finish the job of tax reform, but it made a fatal mistake. It lowered the tax rates again, bringing the top rate down to 28 percent, but attempted to close the so-called tax loopholes without correcting the fundamental problem with the tax code: the misguided definition of taxable income that gave rise to the tax loopholes in the first place. Ironically, the 1986 tax “reform” actually worsened the tax impediments that discourage work, saving, investing and entrepreneurial risk-taking by taxing capital gains as so-called “ordinary income,” which they certainly are not.
Twice subsequently (1990 and 1993) Congress ratcheted the rates back up again, and by 1993 we had the worst of both worlds: Most of the 1986 tax rate reductions were repealed, but nothing was done to improve the definition of taxable income and to remove the impediments to economic growth.
In 1996, the National Commission on Economic Growth and Tax Reform, which I was privileged to chair and on which Treasury Secretary John Snow served, concluded that “the current tax system is indefensible and beyond repair. It is overly complex, burdensome and severely limits economic opportunity for all Americans.”
Despite the consensus that the current tax code is fatally flawed and should be ripped out by the roots and replaced with a low-rate tax system that taxes income only once, the American political system seems by design to be incapable of producing the kind of “big-bang” reform this transformation would entail. The sheer uncertainty of how so drastic a change would affect people makes them hesitant to trade the devil they know, no matter how wicked, for the promise of something better they don’t know, no matter how attractive that promise may be.
The result is that economic growth in all 50 states and in all of the U.S. territories is significantly less than it could be, and government revenues are lower. Struggling areas and territories with high rates of poverty suffer disproportionately from a tax system that discourages saving, investment and risk-taking because these areas are unable to attract the critical capital required to get them to the point of economic takeoff. Moreover, gimmicks such as tax subsidies, tax credits and rebates, corporate welfare, government-backed grants and loans only distort capital markets more and create greater dependency in these struggling economies.
Over the years, individuals and businesses have developed strategies, shelters and havens to cope with the irrationally burdensome federal tax system. In addition, there are myriad special interest groups and organizations who have successfully lobbied Congress for preferential tax provisions, which benefit them at the expense of the rest of American taxpayers, who would resist fundamental tax reform to the very death.
To break through this gridlock, we at Empower America have proposed a nationwide system of federal enterprise zones we call Zones of Choice, in which individuals and businesses would be allowed to choose whether to be taxed under the current tax system or under an alternative, reformed tax system. The reformed code would be a simplified, single-rate system that taxes income only once and allows the poor to get access to capital. Establishing such zones of choice in all 50 states and the U.S. territories will demonstrate at the state and local levels the benefits and feasibility of fundamental tax reform in a practical manner that minimizes political obstacles and uncertainty and maximizes the economic benefits of systemic change in our system of taxation.
When Congress takes up the president’s tax proposals, there will be spirited debate and probably considerable compromise. One item that could receive widespread bipartisan support is the idea of enterprise zones of choice that could not only help demonstrate the benefits of tax reform but also bring an immediate boost to areas around the nation and in the territories where the economy is struggling and unemployment is high. It’s a win/win proposal.