Both political parties, both presidential candidates, most prominent economists and economics journalists, in other words, most opinion makers, favor faster economic growth. I have had several recent posts on this topic, here and here, pointing out especially the need to increase the rate of growth of worker productivity which in turn is heavily influenced by the rate of new business investment.
One of the most valuable policy changes in this respect is tax reform, with lower marginal rates paid for by closing loopholes and shrinking deductions. The Republican House of Representatives has developed an excellent plan, “A Better Way,” which includes such extensive tax reform.
Simplification. The seven current individual tax rates would be reduced to just three: 12%, 25% and 33%. All deductions would be eliminated except for mortgage interest and charitable contributions. The standard deduction would be almost doubled. A 50% exclusion for capital gains, dividends and interest income would lower those tax rates in half.
Business taxes. The corporate tax rate would be cut from 35% to 20%, again by eliminating most deductions, and a territorial system adopted whereby taxes are only paid in the country where business is conducted. Immediate expensing for new investment would replace multiyear depreciation.
Effects. Base broadening by eliminating deductions will add 6.5 million new taxpayers. The number of taxpayers taking the standard deduction will increase by 37 million (from 70% to 95%). Total tax revenue will decrease by $227 billion over ten years. The effective marginal tax rate is slightly lower for most income groups.
Conclusion. The overall lower tax rates will boost economic growth. The ten year loss of tax revenue, while relatively small, is still a detriment and should be eliminated by shrinking the remaining mortgage interest deduction (which primarily benefits the wealthy).
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?
All four of the major presidential candidates have tax plans. Hillary Clinton would make small tweaks in our current tax system. Bernie Sanders would raise current taxes substantially. Both Donald Trump and Ted Cruz would both radically reduce the size of the federal income tax but would also greatly add to the national debt over the next ten years.
I have been trying to make the case on this blog that fundamental tax reform is the best thing we can do to get the economy growing faster in order to create more and better paying jobs. I have also discussed a specific way to accomplish fundamental reform, namely the so-called Competitive Tax Plan proposed by the tax law expert, Michael Graetz. It is a progressive consumption tax, a so-called Value Added Tax. As reviewed in yesterday’s Wall Street Journal by Reihan Salam, the editor of the National Review, the Graetz Plan has these features:
A broad-based VAT of about 14% on goods and services.
Families earning less than $100,000 per year are exempt from the income tax. The tax rate would be 15% for incomes between $100,000 and $250,000 and 25% above this level.
The payroll tax (supporting Social Security and Medicare) would be greatly reduced for all workers earning less than $40,000 per year.
The corporate tax rate would be lowered to 15%, making it among the lowest in the world.
The Graetz Plan is revenue neutral as verified by the Tax Policy Center.
Think of the incredible advantages of such a tax plan. Of the expected 145 million tax returns for this year, 120 million would no longer be necessary. Extravagant deductions such as for mortgage interest would have much less political support. The low corporate tax rate would bring jobs back to the U.S. instead of sending them overseas. The rampant cronyism involved in tax breaks being handed out by Congress would be greatly reduced.
What is not to like about the Graetz Plan?
In my last post I presented the argument that voters are often more reasonable than the populist leaders who are trying to appeal to them. They would rather hear something more optimistic than rage against a dangerous world. But there is a difference of opinion on how to reach these voters:
Leading Democratic presidential candidate Hillary Clinton endorses the Buffett Rule which calls for millionaires to pay a minimum tax of 30% on their income. Says Clinton, “I want to go even further because Warren is right. I want to be the president for the struggling, for the striving and the successful.”
All of the Republican presidential candidates, including Donald Trump, have tax reform plans which will grow the economy but none of which are revenue neutral. In other words, they will all add to annual deficits and therefore make our debt problem much worse than it already is.
The nonpartisan Tax Foundation has issued a new report, “Options for Broadening the U.S. Tax Base,” which proposes capping itemized deductions at $25,000 per individual combined with
i) cutting the corporate tax rate to 27%
ii) cutting the top three ordinary income brackets by 5%, and
iii) implementing a top capital gains tax rate of 20%.
Such a plan would be revenue neutral and would lead to a long term GDP gain of 2.7%, a long term wage gain of 2.2% and a ten year dynamic revenue gain of $759 billion.
The Clinton plan would bring in up to $50 billion per year in new tax revenue but would do little to boost the economy. The Republican presidential tax plans are fiscally irresponsible. The Tax Foundation plan would boost the economy and reduce deficits rather than increase them. Other specific reforms would boost the economy even more.
In other words there are clear cut ways to create more jobs and raise wages. This is a message which should appeal to the angry and disaffected voters who are attracted to Donald Trump.
There is a very important debate going on in the country right now as I have discussed in my last three posts:
The Republican presidential candidates are proposing big tax cuts to stimulate the economy but at the cost of huge increases in annual deficits and the accumulated debt.
The Democratic candidates want to raise taxes on the wealthy but even raising the top tax rate from 39.6% to 50% would have only a modest effect in lowering income inequality.
The Tax Foundation has an excellent plan to lower tax rates for all in a revenue neutral manner by closing loopholes and limiting deductions. Their plan would give the economy a big boost and actually lower deficits by bringing in more tax revenue.
Now comes Paul Krugman in Friday’s New York Times, “Austerity’s Grim Legacy” saying that “Some of us tried in vain to point out that deficit fetishism was both wrong-headed and destructive, that there was no good evidence that government debt was a problem for major economies, … And we were vindicated by events. More than four and a half years have passed since Alan Simpson and Erskine Bowles warned of a fiscal crisis within two years; U.S. borrowing costs remain at historic lows.” How can such an obviously intelligent and articulate economist miss what is so very, very clear to so many lesser mortals? Interest rates will not stay low forever! And when they do go up, interest payments on our rapidly expanding debt will skyrocket! The Congressional Budget Office estimates that the interest payment on our debt will increase from 1.7% of GDP today to 3.6% of GDP in 2025, or $827 billion in 2025 compared with $227 billion in 2015. Where will the money to pay this new $600 billion expense come from?
It is absolutely crazy not to take our enormous debt seriously. We simply must put this huge debt on a downward path as a percentage of GDP. It can be done but it will take a concerted effort by our national leaders to do it.
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. The 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.
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.
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.
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?
“The single biggest threat to our national security is our debt”
Admiral Mike Mullen, former Chairman of the Joint Chiefs of Staff
My last blog, “Why the National Debt Is Such a Threat to the U.S.” observes that our debt is very large by historical standards and will just keep getting worse under current policies now in effect. This has many severe consequences for the well-being of our country.
What do we do about it? We have to shrink the size of our annual deficits which are continuing to make the debt bigger and bigger. The deficit for the 2014-2015 budget year just ended is $483 billion which is 2.8% of GDP. Since our economy has been growing at a rate of only 2.2% for the past five years, this means that the debt is still growing faster than the economy. We have to do better than this. The above chart from the Congressional Budget Office shows that the main contributors to the deficit, and therefore also the debt, over the next 20 years, will be entitlements (Social Security, Medicare and Medicaid) and interest payments on the debt. All other programs, i.e. almost all of traditional federal spending, will decrease as a percentage of GDP.
This means that there are just two basic ways to solve our debt problem: trim entitlement spending and/or increase government revenue. We’ll need to do both. Furthermore, it is unrealistic to expect middle-income and lower-income people to pay higher taxes when their wages have been stagnant for many years. New tax revenue will have to come from the wealthy including upper-income wage earners. The best way to do this is by cutting back on the annual $1.2 trillion in loopholes and deductions built into the tax code. Only one Senate candidate from Nebraska is willing to both trim entitlement spending and raise additional tax revenue: Jim Jenkins, a registered independent from Calloway. The Democratic candidate, David Domina, will not support any significant reining in of entitlement spending. The Republican candidate, Ben Sasse, is too beholden to wealthy contributors to be willing to raise their taxes by cutting back on their tax deductions.
We badly need elected representatives in Washington who will make it their top priority to “fix the debt.” Jim Jenkins is such a person. I hope you will vote for him!