Conventional wisdom holds that being pro-growth is synonymous with being anti-tax. But as endless deficits spook the bond market, we need to curtail the reign of hot checks. Restoring fiscal sanity will require spending discipline. It will also demand that we curb the tax expenditures that will claim $2.3 trillion in federal revenue this year, more than Medicaid and Medicare combined. To that end, the tax code is overdue for a good housecleaning. We should look to the bipartisan 1986 tax reform initiated by President Ronald Reagan for guidance.
Both parties have contributed to the current fiscal calamity, and we should be honest about the history. President Bill Clinton and a Republican Congress balanced the budget and created surpluses four years in a row before Vice President Dick Cheney pronounced that "deficits don't matter." Sen. Mitch McConnell infamously observed behind closed doors that no politician had ever lost office by spending more money. The two parties have different priorities when it comes to spending, but they both contribute to the same deficit, which raises costs for businesses and homeowners.
The tax code's various loopholes -- deferrals, deductions, new definitions -- are costly and encourage the wrong behavior. The code has evolved from an instrument designed to create wealth to one designed to preserve it. Today, those who would ordinarily pay the largest tax bills spend untold time and energy playing legalized games of "catch me if you can" with the Internal Revenue Service. It's absurd for Mark Zuckerberg to claim that his exercised stock options should qualify for the R&D tax credit. Minimizing any family's tax bill has become so complex -- the number of loopholes has more than doubled over the past several decades to 271 -- that some children of wealthy families attend retreats to learn how to manage their inheritances.
It's no picnic for everyone else, either. The IRS already has access to sufficient information to empower nearly half of taxpayers to file at the touch of a button. But the code has become so complicated that tax professionals make billions off fees paid by working- and middle-class families. The stampede to cut high-end liability has obscured the damage done to the economy. The lobbyist group Business Roundtable long advocated lowering the corporate rate to 25%, but in 2017 President Trump insisted it be slashed to 21% with no commercial purpose in mind.
To halt the games and instead invest in real growth, we should look back to an earlier age. Forty years ago, Mr. Reagan reached across the aisle to work with a powerful Chicago Democrat, House Ways and Means Committee Chairman Dan Rostenkowski. They were committed to simplifying the code and closing loopholes. We should take four steps toward the same end.
First, end the practice of wealthy families' borrowing against their equity to cover their expenses tax-free. We should simultaneously eliminate the stepped-up basis that allows them to pass fortunes from one generation to the next free from capital-gains taxes. This policy has nothing to do with driving economic growth and serves only to preserve inherited wealth.
Second, close the loopholes that allow companies to stash profit in overseas tax havens to avoid U.S. taxes. American companies that profit from selling their products and services to American customers shouldn't be able to ascribe their earnings to foreign accounts. A vast share of the 271 loopholes are corporate, further encouraging companies to game the system. To be effective, reforms will need to work hand in hand with an enforceable international floor. Instead of alienating our allies, we should collaborate with them to ensure that multinational corporations aren't playing us off each other.
Third, rescind the policies that let private-equity fund managers pay lower tax rates than firefighters, police officers and teachers. The carried-interest rule suggests that those in the business of buying and selling companies need the incentive of a special tax break. They don't.
Finally, raise the capital-gains rate closer to the rate that prevailed during the late 1980s, when it was the same as the tax on ordinary income. It makes sense to encourage investment, but when the economy was booming during the Reagan and Clinton administrations the top capital-gains rate was 28%, well above today's 20% (plus the 3.8% ObamaCare investment income tax). You can't claim that narrowing the gap between passive income and earned income would undermine the incentive to invest when we saw robust growth in exactly those conditions.
We won't be able to restore the nation's fiscal balance by closing loopholes alone -- we'll also need to make tough choices on the spending side. After Reagan and Rostenkowski simplified and tightened the code, both Presidents George H.W. Bush and Clinton reached bipartisan deficit-reduction agreements that reined in spending and introduced pay-as-you-go rules to restore fiscal discipline. It's time we began making hard choices again, such as placing a four-year cap on spending so that we aren't wasting $38 billion on ICE detention centers communities don't want or need.
Charlie Munger famously said: "Show me the incentive and I'll show you the outcome." If interest rates continue to climb because an overly complex and misdirected tax code drains the Treasury, Washington is bound to stymie private investment. Let's close the loopholes that spur the wealthiest taxpayers to spend their time trying, however legally, to game the system. Washington's goal should be to create wealth, not protect it.
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Mr. Emanuel, a Democrat, served as a U.S. representative from Illinois (2003-09), White House chief of staff (2009-10), mayor of Chicago (2011-19) and ambassador to Japan (2022-25).
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