Pro-growth tax reform, yes; discriminatory taxes, never

During the first 2012 presidential debate, Mitt Romney delivered one of the more memorable lines of the campaign, saying to President Obama, “you don’t just pick the winners and losers, you pick the losers.”  All humor aside, the real point they both missed is that the government should not be in the business of doing the picking.  Instead, the government should create a pro-growth environment with a level playing field and then get out of the way, allowing businesses to create their own success.

Remember, when the tax code was created, its sole purpose was to raise the necessary funds to run government. But in today’s world, the tax code has many more facets, including income redistribution, rewarding favored industries, and punishing unfavorable behavior.

{mosads}Positive, pro-growth tax reform, however, will rid the tax code of such added complexity and move toward a fairer, flatter tax structure that increases the incentives to save, invest, and produce. This is the path toward increased employment, production, and renewed prosperity in America. Such a philosophy should be at the forefront of the various tax reform proposals making their way through Congress this session.

For instance, hard-charging House Ways and Means Chairman Paul Ryan (R-Wis.) says he is sprinting towards a late-summer finish line with a plan to reform the corporate tax. Judging by his views and voting record, Ryan is on track towards the right kind of reform: the lowest possible tax rate, on the broadest possible base.

He and his colleagues need to avoid as much as possible special interest provisions promoting one sector or punishing another. Often such provisions find their way into policy proposals in the name of trade protectionism. Unfortunately, there is always pressure on the tax-writers to be diverted down a blind alley.

One such example comes from Obama’s Fiscal Year 2016 Budget in which he proposed to deny the standard business cost deduction to U.S.-based, foreign-owned companies for reinsurance premiums they pay to foreign reinsurance affiliates.

This reinsurance is “backup coverage” for insurance companies — a way of spreading the risks for potential major losses like earthquakes, plane crashes, and hurricanes. An international capital base lets insurers pool the risk of hurricanes in Florida with those of earthquakes in Japan. Since these events almost never happen at the same time, insurers can provide more insurance on the same capital base by spreading the risk. This also gives consumers the benefit of a more competitive marketplace and lower prices.

Under President Obama’s budget, all other insurance companies would still receive a deduction for their reinsurance premiums. While the proposal, also pushed in a variety of forms by Sen. Robert Menendez (D-N.J.) and Reps. Richard Neal (D-Mass.) and Bill Pascrell (D-N.J.), may have some surface appeal, the disallowance of the deduction for premiums paid to foreign reinsurance affiliates is little more than a protectionist tariff in disguise.  In essence, the “deduction disallowance” imposes a huge penalty on international insurance companies that transfer risks to other companies who share ownership and group management. Ending these affiliate reinsurance transactions would decrease the supply of insurance.

And, as anyone who has taken Economics 101 would anticipate, decreasing supply will make things a lot more expensive. But insurance is indispensable to founding and building businesses. This proposal amounts to a tax increase on reinsurance, which will discourage capital investment, economic growth, and job creation.

The Cambridge, MA-based Brattle Group finds that consumers could pay as much as $130 billion in extra insurance costs over the course of a decade. The news gets worse. According to a model developed by the non-partisan Tax Foundation, private business capital could decline by $7.8 billion, and household capital by $2.2 billion, for a total capital reduction of nearly $10 billion. As a result, the proposal would cost the private sector $4 for every $1 in revenue the tax increase raises.

Moreover, because this tax increase is so blatantly protectionist, US-based insurance companies would likely suffer foreign trade retaliation in response to the U.S. government’s trade protectionism in the tax code. The U.S. might even face sanctions from the World Trade Organization.

By denying a deduction for a standard and legitimate business expense – and by targeting foreign but not US-based companies – the Obama-Menendez-Neal-Pascrell proposal is a textbook case of bad tax policy: creating a very high tax rate on a very narrow tax base.

This is precisely the type of policy we need to avoid during tax reform. Tax policy should raise the funds necessary to run the government, while promoting economic growth by being even-handed and easily understandable.

If public officials want to discourage disfavored activities, they should give speeches denouncing their demons du jour, not enact discriminatory taxes that limit trade and punish entrepreneurs, investors, and working Americans.

Laffer is an economist who served on President Reagan’s Economic Policy Advisory Board. His is currently policy co-chairman  of the Free Enterprise Fund and serves on the “Board of Scholars” of the American Legislative Exchange Council (ALEC).