Several of my recent posts have been devoted to the topic of faster economic growth, see, for example, here. One way to do this is by making it easier to start and grow a small business. Another way is with broad-based tax reform. House Republicans have just released the outline of a plan for fundamental tax reform, “A Better Way: A Pro-Growth Tax Code for All Americans.” It has the following main features:
The current seven tax brackets for individuals are condensed to just three: 12%, 25% and 33%.
The standard deduction of $12,600 (for joint returns) is raised to $24,000 and the $4,050 personal exemption is eliminated. This feature means that fewer filers will need to itemize deductions.
In fact, all itemized deductions for individuals are eliminated except for mortgage interest and charitable contributions.
To encourage business creation and expansion, the pass through tax rate for small business will be 25%. Full and immediate expensing for investments in new equipment and technology will be allowed.
The corporate tax rate will drop from 35% to 20%, paid for by eliminating dozens of tax carve-outs and deductions, including net interest expensing. A territorial system will be established whereby multinational firms will no longer be taxed both abroad and at home for the same dollar of income. This will encourage the multinationals to keep production facilities in the U.S. and to bring home foreign profits for reinvestment here.
The purpose of this plan, according to Kevin Brady, Chair of the House Ways and Means Committee, is “to rev up the economy, cut taxes on business, simplify the code and let American families file on a postcard.” The authors of the report claim that this tax proposal is revenue neutral, i.e. will not lower tax revenue, on a dynamic scoring basis, taking resulting economic growth into account. If this assertion holds up under nonpartisan analysis, then this is an excellent proposal which deserves broad support.
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. There 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?
I have been focusing lately on America’s two biggest fiscal and economic problems:
How to boost the economy in order to put more people back to work
How to either cut spending or raise revenue in order to shrink the deficit.
A few days ago in “The Great Wage Slowdown and How to Fix It,” I laid out a fairly specific proposal to make a substantial reduction in tax preferences in order to cut tax rates across the board and especially for the 64% of taxpayers who do not itemize deductions. These are the middle- and lower-income workers with stagnant incomes who would likely spend any tax savings they received thereby giving the economy a big boost. Let’s examine whether or not this is a realistic course of action. The above chart from the Congressional Budget Office document, “The Distribution of Major Tax Expenditures in the Individual Income Tax System,” shows that, for example, the upper 10% of households by income receive about 40% of the total $1 trillion in individual tax expenditures per year. Furthermore, this same top 10% of tax payers have an income of about $140,000 or more (Congressional Research Service). My basic idea is to shrink tax preferences by $250 billion per year and to lower tax rates for middle- and lower-income non-itemizers by this same amount. If we assume that they would spend 2/3 of this new income, it would boost the economy by $170 billion per year which is 1% of GDP.
A reasonable way to achieve this savings is to expect higher income earners to contribute a greater percentage of their tax preference savings. For example:
top 1% contribute $110 billion (2/3 of their total deductions).
top 96th % to 99th % contribute $50 billion (1/2 of their total deductions).
top 91st % to 95th % contribute $30 billion (1/3 of their total deductions).
top 81st % to 90th % contribute $30 billion (1/4 of their total deductions).
top 61st % to 80th % contribute $30 billion (1/5 of their total deductions).
this gives a total of $250 billion in tax preference savings.
This back-of-the-envelope calculation is not intended to be definitive but rather to suggest what can be done along these lines. Those who are more well-off need to make bigger sacrifices in getting our economy back on track.