The Republican tax plan has many good features and is now moving along in Congress. The best feature of all is reducing the top corporate rate from 35% to 20%. This will make the U.S. internationally competitive and create a strong incentive for all multinational companies to conduct more business in the U.S. and for U.S. multinationals to bring their profits back home for reinvestment.
The Tax Foundation estimates that the Senate version of the Plan will lead to the creation of 925,000 new jobs and an after tax income gain of $2,598 for a middle-income family over a ten year period.
But there are several parts of the plan which could be significantly improved. For example:
Revenue neutrality, at least on a dynamic basis (taking growth into account) is essential. Our national debt is way too large to ignore.
Shrinking more deductions, to achieve revenue neutrality. The mortgage interest deduction should be eliminated completely, not just limited to $500,000 mortgages. Same for the state and local tax deduction.
More progressivity. Keep the estate tax to bring in more tax revenue. Scrap the lower 25% rate for a pass-through business tax because it will be too easy to abuse. The Congressional Budget Office has estimated that eliminating the individual mandate for the ACA will save $338 billion over ten years. It will also save millions of Americans from having to pay a tax penalty of $695 or more for not having health insurance.
Emphasis on growth. Make expensing (i.e. immediate write-off) for new investment a permanent feature rather than limited to five years only.
Conclusion. There are lots of good features in the Tax Reform Plan. Several changes would make it even better. As soon as it achieves stability in the legislative process, the CBO will analyze its fiscal and economic effects. At this point revenue neutrality will be essential for achieving broad support.
With the unemployment rate now down to 4.2% and household incomes having recently reached an all-time high, the first order of government business should be:
Fiscal responsibility which means to start reducing the size of the national debt, which is now 77% of GDP (for the public part on which we pay interest), the highest since the end of WWII. The only practical way to do this is to begin to shrink the size of our annual deficits from the very high level of almost $700 billion for the 2017 Fiscal Year which just ended on September 30.
A responsible budget for the 2018 Fiscal Year can have a deficit of at most $500 billion which amounts to 2.5% of our total GDP of $20 trillion. A realistic forecast for economic growth in the coming year is 2.5% of GDP which means that a deficit for the 2018 FY of $500 billion would at least not increase our debt as a percentage of GDP.
Budgets for later years need to actually shrink (not just hold steady) the debt. The goal should be to decrease annual deficits down close to zero which would mean achieving a balanced budget. The Congressional Budget Office projects that the cumulative deficits will climb by $10 trillion over the next ten years under current policy, pushing the debt up to 91% of GDP in 2027.
Tax reform, to be considered next by Congress, is likely to stall if it is not pursued within a sensible fiscal policy just as healthcare reform stalled last summer. Sensible tax reform, both growth enhancing and revenue neutral, is quite doable and will make the debt problem that much easier to solve.
Conclusion. It cannot be emphasized too strongly that our rapidly growing debt puts us in a dire fiscal bind. We must change policy significantly and soon or else we will put our prized liberty and prosperity in grave danger.
In my last post I made the case that the two fundamental principles for effective tax reform are:
Faster economic growth, to create more jobs and bigger pay raises.
Revenue neutrality, since more debt at this time is just too risky.
And then I went on to suggest the specific changes in the tax code which would achieve these goals:
Reducing the corporate tax rate to approximately 20%.
Full expensing for business investment replacing depreciation spread out over many years.
Simplification of rules for individuals such as fewer tax rates and fewer credits.
Achieving revenue neutrality by eliminating as many deductions as necessary to pay for the above tax rate cuts.
There are different ways to accomplish all this and I recently described one attractive plan put together by the Tax Foundation. The Republican Congressional Leadership (Big Six) has proposed a different plan which has been analyzed by the nonpartisan Committee for a Responsible Federal Budget. Unfortunately CRFB concludes that this plan will cost $2.2 trillion over ten years in lost revenue. But it could be modified in the following ways to become revenue neutral:
The mortgage interest deduction is maintained but limited to one dwelling and $500,000, down from the current limit of two homes and $1 million.
The tax exemption for employer provided health insurance is limited. This not only increases tax revenue but also forces the 150 million Americans who receive health insurance from their employer to take an active role in holding down the cost of healthcare.
Drop the proposal of establishing a maximum “pass through” rate of 25% for business owners. Any such proposal would be subject to wide spread abuse. Businesses would be benefitting from the full expensing provision above and their owners should pay taxes at the same rates as everyone else.
Keep the estate tax until annual deficits are greatly reduced. It only brings in $20 billion per year but every little bit helps.
Conclusion. These common sense changes in the Big Six plan would make it revenue neutral and still capable of achieving a significant boost to the economy.
I have been criticizing the Republican Congress lately for straying from fundamentals in attempting to reform healthcare and tax policy. What are the fundamentals for tax reform? In my opinion they are:
Faster economic growth. The economy has averaged only 2% annual growth since the end of the Great Recession in June 2009. The unemployment rate has slowly fallen to the current 4.4% level and a labor shortage is now developing. But wage gains for the broad middle class and especially blue collar workers have been minimal. Faster growth will put pressure on employers to raise wages faster to acquire the skilled workers they need.
Revenue neutrality. With the public debt (on which we pay interest) now 77% of GDP, the highest since the end of WWII, and predicted by the Congressional Budget Office to keep getting steadily worse without major changes in policy, it would be the height of irresponsibility for Congress to approve tax changes which increase our annual deficits.
Given these two basic principles, what should be the specific changes made to tax law? Here are my priorities:
Lowering the corporate tax rate from its current level of 35% to a competitive level, approximately 20%, with other developed countries. This would be a huge incentive for our multinational corporations to bring their foreign profits back home.
Full expensing for business investment is allowed, replacing depreciation over a period of years, to speed up new investment.
Simplification of the rules for individuals, such as with fewer tax rates and fewer credits, so that fewer errors will be made and a greater proportion of true tax liabilities will be collected.
Create revenue neutrality for the above tax rate cuts by eliminating, or at least shrinking, many deductions and closing loopholes.
Conclusion. Tax reform will be highly beneficial for the economy if it is done correctly. This means ignoring many of the special interest provisions which have also been suggested for conclusion. I will discuss these in my next post.