What would smarter tax reform look like?

By Payson Peabody

We’ve made the case that Congress should pursue bipartisan tax reform as a way to make the tax system simpler and fairer; to create jobs and boost incomes for American workers; and to increase public confidence at a time when trust in government is at or near historic lows.

To help guide the debate, SIFMA has prepared a white paper on the priorities the financial industry would like to see reflected in a comprehensive, pro-growth tax reform package. SIFMA urges policymakers to focus on creating a territorial tax system that

· Recognizes the unique characteristics of the financial services industry,

· Is fair and equitable for U.S. financial services companies and investors, and

· Encourages foreign investment in the United States and does not discriminate against non-U.S. financial services companies seeking to compete in American markets.

The full document submitted to the Senate Finance Committee can be found here. A summary of the key priorities follows:

Reform the System for International Taxation

The U.S. is one of the only remaining countries that continues to tax its residents on income derived from the active conduct of a foreign business. Most of our trading partners have moved toward a more competitive exemption or partial exemption system, under which business income earned by foreign subsidiaries is taxed primarily in the country where it is earned and anti-base erosion regimes serve to protect the home country tax base.

SIFMA believes that a well-crafted exemption system, with appropriate safeguards against base erosion, would be strongly beneficial to the United States economy.

Preserve Incentives for Savings and Investment

Because of their tax-deferred status, retirement plans may come under scrutiny as a way to reduce the deficit.

SIFMA participates in a coalition of service providers, plan sponsors and HR professionals — the Coalition to Protect Retirement — with the goal of preserving the tax incentives that are critical to encouraging Americans to save for retirement and to businesses sponsoring plans for employees.

SIFMA and its members consistently have advocated for low federal income tax rates on savings and investment and supports low capital gains rates and parity between the rates for capital gains and qualified dividends.

We believe that these preferential rates provide a necessary and powerful incentive for investments that benefits retail investors and strengthens the U.S. economy, and that Congress and the Committee should be mindful of preserving these incentives as discussions about tax reform unfold.

The United States has a relatively low savings rate which means we have to rely on foreign investment to provide the capital needed to make American workers productive. According to the UK Office of National Statistics, American workers are among the most productive in any advanced economy. Productivity translates into higher salaries and a higher standard of living for all Americans, but businesses need access to capital from domestic savings to sustain our current success. Our tax code already favors current spending over savings, but we at least provide some incentive for long term investment in the preferential rates for long term capital gains and dividends. Diminishing that incentive would be short-sighted and, in more than one sense, counterproductive.

Preserve the Federal Tax Exemption for Municipal Bonds

State and local governments benefit from the tax exemption through significantly lower borrowing costs. Municipal bonds are used to finance a wide variety of infrastructure like schools, roads, bridges, airports, water and sewer systems, hospitals and many others. The tax exemption lowers the cost of financing these projects and encourages more infrastructure investment.

The tax exemption is better than direct subsidies for infrastructure investment because bonds must be repaid, forcing a market test of the project’s viability.

Taxation of Interest

There have been tax reform proposals that limit the deductibility of interest for business taxpayers. Any comprehensive changes to the taxation or deductibility of interest for business taxpayers would have broad impact throughout the economy and need to be carefully considered. It’s not clear yet from the tax reform outlines we have seen to date what policy makers have in mind.

Of course, these suggestions are only the tip of the iceberg in what needs to be a comprehensive, top-to-bottom reform of the existing tax code. But taken together, these and other needed changes wills make the system fairer, more broad-based and more responsive to the realities of a 21st century economy.

Payson Peabody is Managing Director, Tax Counsel and Associate General Counsel with the Securities Industry and Financial Markets Association (SIFMA).