Tax writers should look at the effective tax rate


Republican lawmakers and the Trump administration are determined to forge ahead with tax reform. That’s a good idea. The federal income tax is a jumble that benefits some industries and individuals more than others even when they earn the same amount of money.

The challenge of reform is that it has so many moving parts. To rectify the system’s many inequities, GOP tax writers in Congress and the Treasury Department have embraced a classic solution. They would reduce tax rates and pay for the change by eliminating tax preferences. The combination would be designed to add to zero, neither raising nor lowering the budget deficit.

Sounds simple, but it isn’t. Keeping track of who wins and who loses in the equation requires extra thought. Newspaper stories often imply that any company or family that loses a favored write off is automatically a loser and, therefore, should oppose the entire exercise.

Not so. To judge tax reform honestly, policy makers and the public need to look at the whole picture. Lots of interests will complain that they are being deprived of a deduction or two, but they will also be helped on the other side of the ledger – with a tax-rate cut.

The combination of the two is what matters in the end.

Luckily, tax experts have an easy way to determine the bottom line. It’s called the effective tax rate, which is the amount that an entity actually pays in taxes expressed as a percentage of income.

This is a very useful tool. Taxpayers could lose multiple tax preferences in the coming reform, but they could end up paying less in taxes because their rates fall so far. Conversely, rate reductions mightn’t be steep enough to make up for diminished credits or deductions.

The only way to know is to calculate the effective tax rate.

At the moment, some industries, like wholesaler-distributors and contractors, pay high effective tax rates while others pay low effective rates, such as technology companies. This fact should guide congressional tax writers. Entities shouldn’t pay radically different amounts of tax if they make the same amount of money. That’s only fair as well as economically sound.

In other words, tax reform should be viewed through the lens of effective tax rates, the amount of taxes that individuals and businesses actually pay.

Lawmakers and Trump administration officials should establish the effective tax rate as the best metric to make meaningful comparisons among policy choices. With it they can clearly determine what the impact of reform will be on different business types, industries and individuals.

Advocates of reform would also be able to bolster their supporters with simple numbers that show how broadening the tax base isn’t always painful when accompanied by deep-enough tax-rate cuts. The effective rate analysis works for every kind of taxable entity: corporations, individuals and businesses that pay taxes on the individual tax-rate system.

Polls show that most Americans think that the tax system is broken and needs to be fixed. That repair should be applied in an even-handed way across all industries. Businesses both large and small agree with this proposition. They also believe that leveling the playing field should be a legitimate goal of reform.

Various groups angling for advantage in the tax reform debate want the public to focus on their own favorite parts of the Tax Code. Some want to look at the rate. Others want to single out particular credits or deductions. But true reform blends the two in a way that can only be assessed by looking at the bottom line – the effective tax rate.

Mark Allen, CEO of the International Foodservice Distributors Association, chairs the Coalition for Fair Effective Tax Rates.