National Enterprise Zones of Choice: Demonstrating the Power of Tax Reform

Empower America ^ | March 2003 | William J. Bennett and Jack Kemp

[Remember_Salamis]

National Enterprise Zones of Choice: Demonstrating the Power of Tax Reform and Ending Economic Dependency March, 2003

Introduction There are three massive, continuing public policy failures underway in the United States. These failures are needlessly preventing millions of people from achieving the American dream. One failure is our misguided approach to lifting people out of poverty; the second failure is the ineffectual way we finance and deliver education; and the third is the self-destructive way we tax ourselves to fund the federal government. It is time to end these failed policies and allow all Americans to achieve prosperity and security for themselves and their families. This paper explores a plan that will take an important step toward removing these impediments to the American dream and leave no American behind.

The Poverty Problem Millions of Americans remain poor with limited hope of achieving a middle class way of life. Despite decades of increasingly intrusive, constantly modified poverty programs and trillions of taxpayer dollars, significant progress has yet to be made. There are two primary reasons for this: A monopoly education system, unaccountable to its consumers and persistently failing to equip students for opportunities to succeed in a modern society, and a lack of economic dynamism and opportunity in poor communities.

The current system provides large disincentives to work. It taxes heavily. The taxes take the form of payroll taxes (a combined 15.3 percent) and, with a modest degree of success by a worker, state and federal income taxes come into play. But there are other taxes. The earned income tax credit (EITC) is phased-out rapidly for those that earn even a modest living (above $13,520 annually). The EITC phase-out alone can be the equivalent of a 21 percent tax. The combination of the phase-out of the EITC, the payroll tax and state and federal income taxes means that those just above the poverty level experience some of the highest marginal tax rates in the country – approaching 60 percent. But consider the loss of subsidized housing, food stamps, Medicaid benefits and other benefits and the cost of commuting and child care. It is not economically rational for many poor people to accept work at less than an annual salary in the neighborhood of $18,000. Taken together, this is what some analysts have called the dependency trap. Combined, these policies prevent the impoverished from developing the habits, work skills and experience necessary to secure better employment. The key to helping people avoid this trap is to give them economic opportunities in their own communities, the skills to take advantage of those opportunities and to eliminate the huge disincentives to exploit those opportunities. The Empower America plan does this.

The Education Problem Second only to family, education is the most critical factor to a child’s future success. Too many American children, however, are cheated from this opportunity to succeed; in 2002, 3.5 million children were attending 8,652 failing public schools nationwide, as defined under the “No Child Left Behind ” Act. In these schools, students are not acquiring the most essential building blocks of learning: nearly two out of every three black children in the fourth grade cannot read at even a basic level. Families want better choices for their children, as demonstrated by the overwhelming Demand in locations where parental choice has been offered. The zones of choice roposal would allow all families to choose a safe and effective school for their children. This is a critical component of any plan to escape the poverty trap and to revitalize communities in this nation.

The Tax Problem Opportunities for all Americans, especially poor Americans, are more likely to develop in a growing, dynamic economy. Yet, the current tax system is complex, unfair, economically destructive and a major impediment to economic growth. The tax system substantially and needlessly reduces the standard of living of the American people, conservatively estimated at 10 to 15 percent.

High marginal tax rates on work, saving and investment, a tax base biased against saving and investment and a complex, loophole-ridden system that taxes different activities at widely varying rates keeps U.S. economic growth rates substantially below the economy’s potential. The Empower America plan, although not including a comprehensive nationwide fundamental tax reform plan, will prove the efficacy of tax reform by providing the most important benefits of tax reform to economically distressed areas first.

National Enterprise Zones of Choice The poorest parts of the United States, including states, territories and the District of Columbia, would be eligible for designation as “National Enterprise Zones of Choice,” in which individuals and firms doing business and living in the zones and subject to the federal income tax would be allowed to choose whether to be taxed under the current tax system or under an alternative, reformed tax system. The reformed tax code would be a simplified, single-rate system that taxes income only once and allows low-income people and small businesses to get access to capital.

To be eligible for designation as an enterprise zone of choice, the area zone would have to be composed of contiguous census tracts, have greater than 10,000 residents, have a poverty rate considerably higher than the national poverty rate (e.g. 2 ½ times higher) and have a median household income less than a specified percentage of the national median household income (e.g. 50 percent). The state or territorial government proposing the zone would also have to demonstrate effort by having enacted laws providing for similar tax treatment within the zone under state or territorial tax law. States and territories would submit proposed zones to the federal government by a deadline early in the calendar year. If the zones meet the criteria set forth in federal law and the requisite state, territorial and local governments adjusted their tax laws as required, then the federal governme nt would be required to quickly announce approval of the proposed zone and the zone would become effective at the beginning of the next calendar year. The only limit on the number of zones would be the number of areas that meet the criteria. Businesses operating within National Enterprise Zones (and which are subject to the federal income tax) that choose to be taxed under the Alternative Reformed Tax (ART) would be allowed immediately to deduct investments placed in service within the zone and to deduct the cost of inventories held in the zone. They would pay taxes at a single low rate on their income derived from the conduct of an active trade or business within the enterprise zone. Individuals living in an enterprise zone and subject to the federal income tax could choose to pay tax on their income at the same low rate with a generous personal exemption. All savings would be treated as if placed in a Roth IRA (Individual Retirement Account), dividends would not be doubly taxed, and there would be no tax on capital gains. These tax reforms constitute powerful incentives to place real businesses doing real things offering real jobs within Enterprise Zones of Choice. The tax reforms:

*Constitute strong incentives to live and build communities within the zones of choice;

*Reward economic dynamism and promote growth and opportunity; and

*Reduce the disincentives people now face to undertake productive activity. Enterprise communities and empowerment zones existing under current law would be eligible to become National Enterprise Zones instead. The incentives under current law would remain in place and be phased out in accordance with current law. After five years, National Enterprise Zones would be reviewed annually to see whether they continue to meet the national enterprise zone criteria. If not, then the zone benefits would terminate five years later.

The Corruption of Enterprise Zones and Other Tax-Subsidy Boondoggles Enterprise Zones, as originally conceived by Jack Kemp while he was a congressman from New York, were designed to reduce tax barriers to employers who would locate and invest within the enterprise zone. The purpose of the zones was to demonstrate the efficacy of reasonable tax policy, with the practical side effect of ‘green lining’ specific economic zones to bring businesses and investment into economically distressed areas, both creating jobs as well as planting the seed corn for long-term community wealth formation and broader national reform. Unfortunately, the enterprise zone idea was turned on its head when it was transformed into empowerment zones enacted in the mid-1990s that were little more than conduits for increased federal grants, subsidized loans and hiring subsidies channeled through targeted tax subsidies. In short, empowerment zones were thinly disguised federal welfare programs for businesses and local governments that in part used the federal tax code as the delivery mechanism. Ironically, empowerment zones were nothing more than a warmed-over attempt to inflict on the rest of the country the same failed tax strategy that the federal government had been attempting in Puerto Rico for years 8 —misguided tax subsidies, corporate welfare and federal spending programs that were supposed to “stimulate” economic growth but which in fact led to further economic stagnation and dependency. Empowerment zones failed because they continued a failed and corrupting practice of federal subsidies rather than serving as a laboratory of experimentation where pro-growth tax policies could be demonstrated. As a result, President Bush has proposed to eliminate all federal funding for the 15 empowerment zones in 2004, and for good reason: they do not work. There is a better way. National Enterprise Zones of Choice would remove barriers to investment and growth within the zones. They would be an example of the power of pro-growth tax policies. Rather than create further dependency on federal programs, they would represent a path toward economic opportunity and permanent freedom from dependency and poverty. They would make it possible for entrepreneurial initiative to flourish in the inner cities, in our rural communities and in every job-deprived community, “green-lining” urban ghettos from the boroughs of East Harlem to the barrios of South Central Los Angeles, from the Reservations of Native American Indians to the territories like Puerto Rico, Guam and beyond.

A Short History of Tax Reform during the Past 25 Years For the past quarter century or so, there has been a serious running dialogue in the United States on why and how to overhaul the complex, confusing, corrupting, confiscatory, and economically destructive Internal Revenue Code. In 1981, Congress took the first serious step toward tax reform when it enacted the Kemp-Roth 25-percent-across-the-board tax rate reductions (a.k.a. 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 stifle saving and investing by favoring consumption and debt. The Code continued the destructive practice of doubly- and trebly-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 in large part been put into 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 wrongly defined tax base, and it frequently increased economic distortion, making matters worse. On top of this, it made the tax code incomprehensibly complicated, 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, again 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. The 1986 tax “reform” indeed 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, in 1990 and again in 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 and nothing was done to change the fundamental definition of taxable income or to remove the impediments to economic growth. Indeed, additionali mpediments were placed into the code in the name of “reform.”

In 1996, the National Commission on Economic Growth and Tax Reform, which was chaired by Jack Kemp 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 growing consensus that the current tax code is fatally flawed and should be “ripped out by the roots” and replaced with a simple, low-rate, pro-growth, saving-and-investment-neutral tax system that is visible and transparent to all who pay it, the American political system seems by design to be incapable of producing the kind of “big-bang” reform this transformation would entail. The shear 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. And, of course, those few who benefit handsomely from the present tax law fight hard to prevent change. The result is that economic growth in all fifty states and in all of the U.S. territories is significantly less than it could be and government revenues and the standard of living of the American people are lower. Struggling areas and territories suffer disproportionately from a tax system that discourages saving, investment and entrepreneurial risk-taking because they are unable to attract the critical capital required to get them to the point of economic take-off. Moreover, gimmicks such as tax subsidies, tax credits, corporate welfare, government-backed grants and loans only further distort capital markets 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. Moreover, there are a myriad of special interest groups and organizations who have successfully lobbied Congress for preferential tax provisions. It is an unholy alliance between these special interests and redistributionalist zealots that resist fundamental tax reform to the very death.

Breaking the Gridlock on Tax Reform To break through this gridlock, we at Empower America propose a nationwide system of National Enterprise 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. Establishing these zones in all fifty states, the U.S. territories and the District of Columbia will demonstrate 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. In the past decade there has been no shortage of tax reform initiatives. Some of the most vigorously debated proposals—the flat tax, the sales tax, the business inflow-outflow tax—have all failed despite widespread support for fundamental tax reform among both political parties and the American public. Unfortunately, the political supporters of various tax reform initiatives often worked at cross purposes, effectively ensuring any serious tax reform proposal was dead on arrival. In the meantime, the tax code became even more of a monstrosity and a subject of ridicule. As a result of this tax policy stalemate, two former Treasury Department officials, Ernest S. Christian and Gary Robbins, along with a group of like-minded colleagues, developed an alternative approach to tax reform that brings together the attractive commonalities of the various fundamental tax reform proposals. They dubbed this approach the “five-easy-pieces of tax reform.” The notion of five easy pieces is to maintain the American tradition of taxing income while lowering exorbitantly high marginal tax rates and incrementally beginning to redefine the tax base to eliminate those existing provisions that discourage work, penalize saving and depress business capital investment, which substantially depress productivity and wage gains. The five-easy-approaches would eliminate the perverse aspects of the current tax code that greatly disadvantage American manufacturers and exporters. The five incremental amendments to the current tax code that would begin the

*Reformation process and simultaneously give the economy an immediate boost are:

*Lowering marginal rates (including capital gains tax rates);

*Eliminating the double tax on corporate earnings;

*Accelerating depreciation, ultimately to the point of 100 percent first-year expensing for business capital investment;

*Expanding roth-ira treatment to all personal saving

*Excluding export and other foreign trade income of american companies from tax In much the same way that other countries already do in the world marketplace.

Each plank of the “Five Easy Pieces” has its own merits and a powerful political constituency. Each component piece has been proposed in one form or another in past legislation. The Bush Administration also recently proposed a package of tax reforms that tracks fairly closely with the five easy pieces. Enterprise Zones of Choice would, in a manner similar to five easy pieces, package together a number of changes to the tax base, along with substantial tax rate reduction, to create an Alternative Reformed Tax. When Congress takes up the president's tax proposals, there will be spirited debate and probably considerable compromise. Enterprise Zones of Choice is one idea that could receive widespread bipartisan support, which not only could help demonstrate the benefits of tax reform in a politically practical manner but also bring an immediate economic boost to areas around the nation and in the territories where the economy is struggling and unemployment is high. Enterprise Zones of Choice is a win/win proposal for America.

Conclusion Empower America’s National Enterprise Zones of Choice initiative will encompass economically depressed urban and rural districts, including U.S. territories, as well as areas adversely affected by free-trade initiatives. These zones are intended to be flexible enough for states to mold programs locally to fit the needs of their particular region, within certain guidelines set forth in federal legislation. The goal of the National Enterprise Zones initiative is threefold:

*Highlight the positive spill-over benefits created by such reform initiatives including economic growth and developmental opportunity;

*Demonstrate the benefits of systemic tax and education reform; and

*Lend a helping hand to depressed regions lacking economic and educational opportunity and areas adversely affected by temporary dislocations associated with free trade policies.

Enterprise Zones of Choice are a politically feasible way to utilize our nationwide laboratories of controlled experimentation—the states and territories—for fundamental tax and education reform. Not only would zones of choice demonstrate the efficacy of tax reform; they also would give economically troubled areas—especially those areas and territories adversely affected by free-trade initiatives—a jump start economically. Additionally, they would give people at the bottom of the economic ladder, as well as many state and local public officials, a stake in tax reform. Meanwhile, they would show the success of parental choice in education, a reform which analysts across the political spectrum agree has been prevented from being fully tried. Finally, Enterprise Zones of Choice would provide a leg-up on the economic ladder, not a hand out, for economically struggling areas of the country. At a time when comprehensive tax and education reform efforts have stalled because of uncertain impact, special-interest gridlock and ideological stand-off, zones of choice offer a means of moving tax reform onto a fast track forward while leaving no American behind.

[Remember_Salamis]

bump!

[q_an_a]

has there ever been a group of more powerful idea men than those in Empower America? has there ever been a group of men that has produced less in 10 years? They must be living off the donations and grants or hiding out in casinos. /sarcasm ON forever about wasted opportunity.

[Remember_Salamis]

Empower America was co-opted into "compassionate conservatism" without the conservatism.

Speaking of co-option, giving "total choice" to inner cities, we could at once (1) provide a test bed for pro-free market ideas, and (2) co-opt the DNC voter base.