More on the Tax Reform Proposals

Criticism of the recent tax proposals seems to have emerged from every quarter. That is to be expected. As the party of opposition, Democrats could hardly do otherwise at this stage in the process. Some fiscal purists worry over deficits. Every interest group that sees a threat to its privileges has raised objections. The proposals also fall short on some counts of disinterested economic reasoning. They are nonetheless a welcome step to make the nation’s tax code more equitable and economically effective.

For the economic purist, every practical proposal has points of dispute. This one’s decision to lower rates for each new individual tax bracket but the highest stands as one example. It speaks to a pointless compromise with the redistributionists. It is not that these people need the help, but this will promote wasteful efforts at tax avoidance among decision makers and get no Democratic votes anyway. It also blunts the economic boost that a more across-the-board cut would bring. The proposal’s increase in the child credit passes economic muster, but the decision to apply it to rather high income levels forces the framers to satisfy deficit hawks by searching for revenues elsewhere where they might have more economically distorting effects. The phase in of estate-tax reductions seems unfair to those whose benefactors die at inconvenient times, but worse will promote all kinds of wasteful maneuvering in the interim.

However much economists might pick nits and partisans criticize to secure narrow interests, these proposals would nonetheless take the country in the right direction. As testimony to that fact and rebuttal to so many objections advanced so far, these Republican plans can claim well-established and bipartisan legislative roots. Their underlying effort to cut back on complicating deductions and credits and use the resulting tax collections to reduce the statutory rates characterizes most every reform proposed over the years from either side of the isle.

This, after all, was the direction taken in the great bipartisan reforms of the 1980s under President Ronald Reagan. It was also the prescription made by President Barack Obama’s 2010 National Committee on Fiscal Responsibility. Colloquially called Simpson-Bowles after its leadership, former Senator Alan Simpson and former White House Chief of Staff Erskine Bowles, it, like the Reagan plan and current proposals, recommended the elimination of special credits and deductions, some 150 of them in fact, and using the additional revenue flows that would create to enlarge the standard deduction, reduce the number of tax brackets, and cut the rate applied to each, including a reduction in the corporate rate from 35 to 28 percent.

Almost all reform proposed over the years since has shared these same general qualities. President Obama pressed Congress several times to adopt Simpson-Bowles recommendations. For all the media complaints about reflexive resistance throughout that time, Republicans offered very similar reforms. Only a few years after Simpson-Bowles, the Republican Chair of the House Ways and Means Committee, David Camp, recommended the elimination or capping of tax breaks and a similar, though slightly more robust cut in statutory rates. President Obama revisited such reforms in his 2015 budget, though with a modest net tax hike. The following year, Republican Paul Ryan, then chair of the House Ways and Means Committee, put forward his version of a “better way,” which, though it had different figures from either Camp or the president, embraced the same principles of simplification and statutory rate reductions.

The reasoning behind all these reform efforts follows the same line, that the changes would create both greater equity and economic efficiency. The arguments used by Simpson-Bowles apply equally to any of them, including today’s. Closing loopholes would force those who had once used the breaks pay their fair share even as it would relieve other taxpayers of the need to make up the difference. Ridding the code of complexity would improve growth prospects by clarifying the tax consequences of any action and by inducing people and businesses to make decisions for economic reasons instead of the political preferences built into the code. The general reduction in statutory rates would further enhance growth prospects by encouraging individuals to work and business to invest more for the future. Lower statutory corporate rates would offer still another benefit by encouraging U.S. companies to repatriate the accumulated earnings they hold overseas, giving the economy a welcome cash infusion for investment.

Even the most hotly contested aspects of today’s proposals can claim these same equity and efficiency arguments. Take, for instance the limitation on the home-mortgage interest deductions. Though real estate agents and construction companies see a threat in the provision to allow deductions on loans only up to $500,000, such a move would hardly harm the economy as some claim. After all, Canada and other countries allow no such deduction and have higher home ownership rates than the United States. It could also claim greater equity, since the full extent of the existing benefit accrues only the nation’s wealthiest while the change would not affect smaller homeowners or renters. The provision that would limit the deduction business can make on interest expenses has only vague implications for equity, but it would add to economic efficiency by removing the current code’s economically unjustifiable tendency to drive business to rely heavily on debt instead of equity financing.

Even the proposed elimination of the estate tax, though it seems to favor the very wealthy, can make an equity claim. The current code, though it seems to tax inheritance heavily, falls mostly on the middling rich, those who inherit family farms or small businesses. They frequently have to sell off their inheritance just to pay the tax. Meanwhile, the very rich, many of whom promote high estate taxes, protect their heirs by giving their money, tax free, to foundations where they see to it that those heirs have comfortable positions with sometimes lavish benefits. Whatever they may claim for the good their foundations do, they ensure that the benefits of their wealth pass from one generation to the next, tax free.

These same matters of equity and economic efficiency support one of the proposal’s most hotly contested elements: the provision to eliminate any write-offs for state and local taxes except $10,000 of property taxes. This is a matter for anxiety among residents of New York, New Jersey, California, Illinois, and a few other high-tax states. Some have gone so far as to accuse Trump and the Republicans of showing vindictiveness this way to states that voted against them. Whatever Trump’s motivations, it is hard to argue that the present arrangements are fair. Because the current code’s deductions deny the federal Treasury monies from high-tax states, it makes up the difference by taxing all Americans at higher statutory rates than it would have to otherwise, effectively subsidizing political decisions made in Albany, Sacramento, Trenton, Springfield, and a few other state capitals. If people in these states want a tax break, they should consult their own politicians and not ask the federal government and through it other Americans to help out, not the least because these others get no say in the process.

Nothing here holds these proposals up as perfect. They are far from it. The debate thus far has made that clear. The debate to come will clarify still more as the process continues in the House and then in the Senate. Hopefully provisions will change for the better. It would, however, hurt the country if this admittedly imperfect reform were to fail. Whether the final legislation includes a net tax cut or is net revenue neutral, even imperfect success at cutting complicating breaks and reducing statutory rates would help the economy and make matters fairer. The elimination special breaks and credits in the code might even restore some faith in Washington by lifting, if only in part, the present prevailing sense that the system is rigged for a favored few.

 

 

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