Category Archives: Tax Foundation

Improving the Republican Tax Plan

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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.

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Achieving Permanent, Revenue Neutral, Pro-Growth Tax Reform

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As Congress turns its attention to tax reform, there is a clear bipartisan consensus on the fundamental principles to employ, see here, here, here, and here.


For example:

  • Promote growth and increase wages for working families
  • Modernize our outdated business and international tax system.
  • Rely on reasonable economic assumptions
  • Make sure that any rewrite of the tax code is revenue neutral

The Tax Foundation has outlined several different approaches to tax reform which meet the above guidelines.  Their Option A is especially attractive:

  • The corporate tax is reduced to 22.5% and full expensing for business investment is allowed.
  • GDP increases by 7.1% long term which translates to a .7% increase per year for ten years, which is substantial economic growth.
  • All income groups, except for the top 1%, will see an after-tax increase in income.
  • Individual Tax brackets are consolidated into the three rates of 12%, 20.5% and 37% and the standard deduction is nearly doubled (from $6350 to $12,000).
  • All itemized deductions are eliminated except for home mortgage interest (limited to $500,000) and charitable contributions.
  • Capital gains and dividends are taxed as ordinary income with individuals being allowed to deduct 40% of qualified dividends and long-term capital gains.
  • The estate tax is eliminated.
  • This tax plan is revenue neutral on a static basis.

Conclusion. There are many attractive features in this plan. Being revenue neutral, with strong economic growth, means that the increase in tax revenue will shrink our huge current annual deficits.  Only the very wealthy top 1% of taxpayers will see their income (slightly) decreased.  The substantial decrease in the corporate tax rate will incentivize multinational corporations to bring their overseas profits back home for reinvestment.

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How Will Hillary Clinton Do on the Economy?

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With Donald Trump dropping in the polls, whirling out of control and unwilling to withdraw from the race, my attention now turns to Hillary Clinton and what she is likely to do as President. I divide this discussion into good news and bad news.

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First the good news:

  • A leading democratic economist, Larry Summers, is on record as strongly supporting faster economic growth.  However, he seems to think that public investment (i.e. more public spending) is the best way to achieve this.
  • The House of Representatives is likely to remain in Republican hands after the 2016 election, even if the margin of control is reduced. The Republican House has an excellent plan to boost economic growth and presumably will be able to bargain for pro-growth policies.

Unfortunately, the current Clinton tax plan is anti-growth. As analyzed by the Tax Foundation, her plan would:

  • Give individuals with an AGI over $5 million a 4% tax surcharge. Taxpayers with an AGI of $1 million or more would pay a 30% minimum tax (Buffett Rule). Carried Interest would be taxed at ordinary income rates. Short term capital gains would be taxed at higher rates up to 39.6%. Most itemized deductions would be capped at a tax rate of 28%. Taxes on small businesses and startups would be reduced.
  • Lead to a 2.6% overall lower level of GDP which would lead to lower levels of wages and jobs.
  • Raise $1.4 trillion in new revenue over the next decade on a static basis which would only really produce $663 billion because of slower growth.
  • Devote all of the new revenue to new spending programs and therefore achieve no deficit reduction and more likely an increase in annual deficits.

Conclusion. The Clinton tax plan has some attractive features such as reducing taxes on small business. But overall it would slow economic growth in the name of reducing income inequality.  A Republican House in the new Congress would likely be able to bargain for a much better plan.

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Can the U.S. Economy Do Better? IV. Let’s Try Tax Reform!

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After seven straight years of anemic, sub-par growth of 2.1% annual growth, one of the most important questions in public policy today is whether or not the U.S. economy can do better. I have devoted my last three posts, here, here, and here, to this question, presenting both positive and negative points of view.
Capture7There are very definitely strong headwinds slowing down growth but there are also specific strategies that are very likely to help speed up growth. One of these is tax reform.  The nonpartisan Tax Foundation (TF) has just issued an excellent report, “Options for Reforming America’s Tax Code” with many good ideas. Here are just three of the many different examples presented.  But they show the powerful effects that would be generated by significant tax reform.

  • Replace the Corporate Income Tax with a Value Added Tax (VAT) of 5%. This would be a huge change but it would also have a hugely positive impact. TF estimates that doing this would boost the economy by 5.5% in the long run as well as boosting tax revenue by a whopping $315 billion per year on average. Furthermore, all income groups from low to high would see equal gains in income.
  • Eliminate All Itemized Deductions Except for Charitable Contributions and Mortgage Interest and Lower the Top Individual Income Tax Rate to 27%. This change would grow the economy 1.1% in the long run and also create 496,000 new jobs. It would also increase tax revenues by $26 billion per year on average. It has the defect of raising incomes more for the affluent than for low- and middle-income groups. But this defect could easily be remedied by, for example, limiting the size of the mortgage interest deduction.
  • Cap the Total Value of Itemized Deductions at $25,000. This popular proposal would not help grow the economy but would bring in almost $200 billion a year in new tax revenue.

What is the better strategy? To be pessimistic and accept the point of view that faster growth is just too difficult or to adopt specific policies which are likely to help?

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Tax Reform and Economic Growth

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In a recent post I pointed out that both Republican and Democratic presidential candidates are being unrealistic with their tax reform proposals:

  • The Republican plans would stimulate the economy but at the cost of huge increases in the national debt, even taking into account the growth effects of these plans.
  • Raising the top tax rate to 50%, a Democratic idea, would bring in an additional $100 billion per year in tax revenue, but this is neither enough to make a big dent on budget deficits or appreciably lower income inequality by redistribution.
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The nonpartisan Tax Foundation has just released a new report, “Options for Broadening the U.S. Tax Base,” describing three different ways to do this:

  • Ending the exclusion of employer-sponsored health insurance
  • Removing the cap on the social security payroll tax
  • Capping itemized deductions at a fixed dollar level

Combined with marginal tax rate cuts, each of these options would lead to substantial economic growth.  However, the first option, ending the exclusion of employer-sponsored health insurance, is unlikely but rather this exclusion could be turned into tax credits as part of further healthcare reform.  Likewise, removing the cap on the social security payroll tax is more likely to be used to raise additional revenue to make social security financially sound for the long run.
However, the single measure of capping itemized deductions at $25,000 per individual could be combined with

  • Lowering the corporate tax rate to 27%
  • Cutting the top three ordinary income brackets by 5%
  • Implementing a top capital gains tax rate of 20%

Such changes would be revenue neutral and would lead to a long term GDP gain of 2.7%, a long term wage rate gain of 2.2% and a ten year dynamic revenue gain of $759 billion.
Conclusion:  it is possible to cut tax rates, broaden the tax base and grow the economy all at the same time and without increasing the deficit.  This is what we should be doing!

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A Much Better Way to do Tax Reform

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My last two posts, here and here, have pointed out the folly of the tax plans of the presidential candidates from both parties:

  • The Republican plans would stimulate the economy but at a cost of huge increases in the national debt, even using dynamic scoring to take into account the growth effects of these plans.
  • Raising the top tax rate to 50%, a Democratic idea, would bring in $100 billion per year, but this is not enough to either make a big dent on budget deficits or lower income inequality appreciably.
    CaptureThe Tax Foundation has just published an excellent guide to income tax policy which makes several good suggestions for using tax reform to boost the economy:
  • Eliminating the deduction for state and local taxes would raise $81 billion per year. Using this revenue to reduce individual income tax rates would grow the economy by 1.77% of GDP over 10 years.
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  • Eliminating the mortgage interest deduction would raise $75 billion per year. Reducing individual tax rates by the same amount would grow the economy by 1.61% of GDP over 10 years.
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  • Capping itemized deductions at $25,000 would bring in $188 billion per year. Reducing individual tax rates by the same amount would grow the economy by 1.99% over ten years.
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Sensible, i.e. revenue neural, tax reform will do wonders for the economy as this study from the Tax Foundation shows. It will bring in more tax revenue to help pay the bills.  It will raise salaries for the already employed.  It will create new jobs for the millions of unemployed and underemployed people who want them.  It will thus reduce income inequality by increasing the wages of people on the bottom. Why is this so hard for so many people to understand?

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The Republicans Need to Get Real about Tax Reform

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The Republican presidential candidates have been releasing tax plans and they have been analyzed by the nonpartisan Tax Foundation. It turns out that most of these plans lose revenue over a ten-year period even on a so-called dynamic scoring basis where the stimulatory effects of the plan are taken into effect.  Such callous disregard for the huge annual deficits we are now running, and our huge accumulated national debt, is totally unacceptable especially from the political party which bills itself as being fiscally responsible.
CaptureThe left-leaning New York Times points this out yesterday in its lead editorial, “Why the Republican Tax Plans Won’t Work.”  According to the NYT:

  • Tax Revenues will need to increase by 40% over the next 10 years just to keep federal spending even with inflation and population growth.
  • Further additional revenues will be needed to pay for health care for the elderly, transportation systems, climate change and likely increased interest payments on the national debt.
  • Thus taxes will have to go up and can only be imposed realistically on the wealthy who have had the biggest income gains in recent years.
  • Democratic presidential candidates do propose tax cuts but only for low- and middle-income Americans.
  • Democrats are calling for new taxes on financial transactions.
  • Democrats also propose to raise wages, support higher minimum wages, support unions and expand profit-sharing and employee ownership.

This is the program the Democrats will be pushing if they win the presidency next year. It has some attractive features but the likely overall outcome will be increased deficit spending, a rapidly increasing debt and a continued stagnant economy.
Meaningful tax and regulatory reform will both be needed to get the economy growing faster than the 2% average of the past six years.  Any credible tax reform program simply must be at least revenue neutral so that, combined with spending restraint, it will put our national debt on a downward path.

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Donald Trump’s Tax Plan: More Bad than Good

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Republican presidential candidate Donald Trump has just released his tax plan. Some of its basic features are:

  • Lowering and consolidating seven current tax brackets into three: 10%, 20% and 25%.
  • The corporate tax rate would be cut from the current level of 35% to just 15%.
  • The income tax on all businesses would be cut to 15% as well.
  • Taxing carried interest at ordinary income tax rates instead of at the lower capital gains rate.
  • Eliminating the Alternative Minimum Tax as well as the Estate Tax.
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The nonpartisan Tax Foundation has analyzed the Trump plan and predicts the following positive long term effects:

  • 11.5% higher GDP,
  • 29% increase in capital investment,
  • 6.5% higher wages and
  • 5.3 million more full-time equivalent jobs.

The tax Foundation also performed an analysis of Jeb Bush’s tax plan and found roughly similar economic benefits except for a lesser number, 2.7 million, of new jobs created. But the Tax Foundation also predicts that the Trump plan would cut tax revenue by $11.98 trillion over ten years on a static basis or $10.14 trillion on a dynamic basis (accounting for economic growth effects of the plan). This compares with a loss of revenue of $3.6 trillion over ten years (static) or $1.6 trillion over ten years (dynamic) for the Bush plan.
In other words, for a substantially larger growth in new jobs under the Trump plan, there is an enormous cost in additional deficit spending.
Conclusion: I have previously criticized the Bush plan for increasing deficit spending and therefore adding to the debt when we should be shrinking it. The Trump plan is much, much worse in this respect, running annual deficits of over $1 trillion per year, moving in exactly the wrong direction.
The Bush tax plan, while needing changes to make it revenue neutral, is far superior to the Trump plan, which simply blows off any concern for deficits and debt.

Why It Is Imperative to Lower the U.S. Corporate Tax Rate

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Several large U.S. corporations have recently announced that they are planning to merge with foreign companies and move their corporate headquarters to a low tax country such as Ireland or Great Britain.  The Obama Administration proposes to disallow such tax inversions by requiring that after such a merger at least 50% of the stock of the new company would have to be foreign owned.  Such a regulatory fix is unlikely to solve a much more fundamental problem.
CaptureThe Tax Foundation has just published a new study, “Tax Reform in the UK Reversed the Tide of Corporate Tax Inversions,” describing a similar situation in Great Britain just a few years ago and what was done to reverse it.  Basically GB took two actions:

  • Implementing a territorial tax system where profits are only taxed in the country where they are earned, and
  • Lowering the corporate tax rate from 28% in 2010 to 21% in 2014 and 20% in 2015. The GB rate had already been somewhat lower than the U.S. rate since the early nineteen-eighties.

These two changes in the corporate tax code have had a dramatic effect. First of all, the number of corporations in GB has been increasing steadily.  By 2017 GB is likely to overtake the U.S. in total number of corporations.
Capture1Secondly, GB actually raises more corporate tax revenue than the U.S. and has been doing so for some years. It should be clear from this discussion that the U.S. should significantly lower its corporate tax rate.
Capture2The biggest problem in doing this is public opinion.  The organization Wallet Hub has just published its “2014 Tax Fairness Survey” which shows that only 10% of the population believes that taxes should be higher on wages than on investment income, whereas 33% thinks the reverse.  An equal tax rate on both is preferred by 57% of respondents.
Capture3This will make it politically difficult, for example, for the U.S. to match GB’s 20% maximum rate on corporations since even middle class U.S. taxpayers pay a tax rate of 25% or higher.  However it might be possible to abolish the corporate tax altogether if dividends and capital gains were then taxed at the same rate as wage income.
The most important thing, however, is to significantly lower the corporate tax rate, one way or the other, in order to incentivize U.S. multinational corporations to keep more of their business and profits in the U.S.

A Glaring Example of the Need for Tax Reform

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Nowadays there are many advocates for both individual and corporate tax reform. I have had several posts recently on this issue. A new report from the Tax Foundation “Is the Tax Code the Proper Tool for Making Higher Education More Affordable?” make a compelling argument that it is futile to try to do this.
CaptureFor example:

  • Education tax credits have grown from a $4.5 billion program for 4.7 million taxpayers in 1998 to a $17.4 billion program claimed by over 7 million taxpayers in 2011.
  • Education tax credits are not well targeted toward low- and middle-income families; almost 50% of the benefits accrue to taxpayers earning more than $75,000, often much more. A much more sensible way to target low income students would be to increase Pell grants.
  • The overuse of tax credits by the federal government has turned the IRS into a spending agency, with refundable tax credits projected to double to nearly $200 billion in the next five years.
  • Trading the elimination of education tax credits for lower marginal tax rates would grow the economy by $19 billion per year and create 121,000 new jobs.

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The authors go on to say: “It is likely that instead of helping, tax credits may be contributing to the rising cost of college education. Colleges are what economists call price discriminators because they can maximize the price that each student can pay.  Because of the Free Application for Federal Student Aid (FAFSA), the college has intimate knowledge of each student’s (or family’s) income and if they are eligible for tax credits, loans, or other financial aid.  This information allows the college to simply adjust its financial aid package in order to capture the maximum value of the tax credit.  Instead of being a helping hand for students, tax credits have turned into a windfall for universities.”
There are many, many reasons to reform the tax code.  The education tax credit is just one very good example!