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Editorial

Tax reform? Hold your breath

For the moment at least, defined contribution plans have emerged relatively unscathed from the major tax reform proposals put forward by the House Ways and Means Committee on Nov. 2.

They still have to run the gantlet of the U.S. Senate, where proposals to convert the standard 401(k) plans to Roth 401(k)s, or at least trim contribution limits could be revived.

The larger, less parochial question remains: Is the bill as presented good for the economy?

To be sure, the country needs tax simplification, but it is not clear, given the 3% GDP growth in the most recent quarters and an unemployment rate of just 4.1%, that it needs an individual tax cut.

A business tax cut could be justified on the basis of international competitiveness, but an individual tax cut is much harder to justify at this time. The Ways and Means Committee could have simplified the individual tax code in a revenue-neutral way.

In stretching to offset the $1.4 trillion cost of the tax cut over the next 10 years the committee made some tax changes that could hurt individuals and the nation in the long run.

For example, the repeal of the credit for clinical testing for certain drugs for rare diseases or conditions likely will slow the development of new drugs for such diseases. Congress should remember the old economic truism: When you tax something, you get less of it. This, in turn, might ultimately mean more workers will die in their prime, harming economic growth. The abolition of the deduction for medical expenses might also contribute to this by discouraging some workers from seeking or accepting treatment for serious illnesses because of the financial hardship it would impose on their families.

The 1.4% excise tax imposed on the net income of the endowments of private colleges also could have harmful effects on the economy by pushing up tuition and room-and-board costs at those colleges, or reducing the aid they provide to students, discouraging enrollment at some of the best private schools. Also, it will contribute a minuscule amount of revenue to federal coffers, so what is the point?

Although members of the committee would no doubt deny it, this bill clearly was written with one motive in mind: To fulfill a need to get a promised tax simplification and cut through Congress this year so as to have something positive for Republicans to campaign on next year.

Even so, there is some evidence the true needs of the economy were analyzed as the bill was developed. What changes to the tax code will enhance economic efficiency?

One the committee can point to is the beginning of a move toward a territorial tax system and the encouragement for U.S. companies to bring profits home from abroad through a low tax on such repatriations. This should end the practice of companies moving their headquarters offshore to avoid U.S. income taxes on their foreign earnings, and it should encourage U.S. companies to expand operations overseas knowing they will be able bring profits home.

Another is the elimination of the bias in the code toward debt over equity financing. Companies will in future be able to decide how to finance operations in the most economically efficient manner, not the most tax efficient.

The new plan also encourages businesses to invest and grow by allowing immediate expensing of capital spending. This should help the economy in the long run.

The changes, with the elimination of many deductions, will make tax reporting easier for individuals and corporations, moving the code to one of Adam Smith's prescriptions: Taxes should be collected efficiently — without high collection costs, including the costs of tax preparation. The changes also move toward the goal of taxes not distorting business decision-making.

On the other hand, because the plan has been presented so late in the year, with provisions applying to the 2017 tax year, there will be little time for accountants and financial advisers, as well as employers and plan sponsors, to become familiar with the new rules and guide clients and complete their tax filing obligations. That violates one of Adam Smith's precepts: Tax systems should be stable and transparent.

The biggest negative in the plan is that it is not revenue neutral, as was the Reagan tax reform of 1986. The House committee having opened the door to tax cuts, the Republican-controlled Senate likely will be tempted to add to the cuts.

That might lead to another look at the revenue losses from defined contribution plan deferrals. The elimination of such deferral by switching DC plans to Roth 401(k)s could help pay for additional tax cuts and keep the deficit to the $1.4 trillion goal over 10 years. So DC plan sponsors and beneficiaries can't breathe easily just yet.​