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.
Granted that it is hard to implement good policy with a populist President like Donald Trump who is most interested in stirring up his base, nevertheless the Republican Congress is making some serious policy mistakes:
Healthcare. The GOP should accept the fact that universal healthcare is a desirable societal goal and is here to stay. The Graham-Cassidy bill is bad policy because some states, such as debt-ridden Illinois, can’t possibly handle healthcare on their own. The fact that the ACA needs operational fixes gives the Republicans leverage for insisting on cost lowering changes in a bipartisan bill.
Tax Reform. The GOP should focus on the most serious problems in our tax system. The complexity of the tax code is partly responsible for the fact that taxes paid lag true tax liabilities by an estimated 16% or $406 billion per year. As an example of waste, the IRS has paid out $132 billion in EITC benefits over the last decade to people who were ineligible.
Our uncompetitive corporate tax rate of 35% encourages multinational companies to leave their profits overseas rather than bringing them back home for reinvestment. Even so, corporate tax revenue as a share of GDP is less than in most other developed countries.
Republicans claim to be the party of fiscal responsibility and should therefore be highly uncomfortable with any tax plan which reduces federal revenue and increases our already very large annual deficits. With a low unemployment rate of 4.4%, any additional artificial (deficit financed) fiscal stimulus is likely to kick off a new round of inflation.
Conclusion. Republicans have a relatively short window of opportunity to enact policy changes beneficial for the country. They need to get serious about what is really important before time runs out.
With Donald Trump expanding the culture wars and the Democrats lining up with the progressive policies of Bernie Sanders, the national political scene seems to be getting more confusing all the time.
And yet there is remarkable consensus on many levels about what the country really needs:
Faster economic growth would help provide more jobs and better paying jobs for the blue-collar workers which both parties are trying to appeal to.
Tax reform meaning to reduce tax rates, shrink deductions and generally simplify the tax code has widespread bipartisan support, as one way to provide the growth which everyone wants.
Shrinking the debt as a percentage of GDP is widely recognized as critical to the future well-being of our country and especially for the poor who are most dependent on social welfare programs. How to curtail spending sufficiently to get this done is inevitably a highly contentious issue.
Healthcare for (almost) all is now the law of the land, given that the GOP has failed to repeal the Affordable Care Act. The emphasis going forward should be to control healthcare costs for both individuals and families as well as for the federal government (the taxpayers).
Immigration and DACA. There appears to be strong bipartisan support in Congress for giving the Dreamers legal status in the U.S. With a very low (4.4%), and still dropping, unemployment rate, a huge labor shortage is developing in many states, including Nebraska. What the U.S. needs is an expanded guest worker visa program so that all employers are able to find the (legal) employees they need to conduct business. Perhaps DACA reform will lead to broader immigration reform as well.
Conclusion. The above issues should be largely amenable to bipartisan consensus. Both parties would benefit from putting aside petty differences and working together to solve them.
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.
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.
Income inequality is a hot political issue today and I have frequently discussed it on this blog. In particular, the chart just below shows that income inequality is only slightly worse since 1979, after government transfers and federal taxes are taken into account.
The AEI scholar, Mark Perry, has analyzed the 2016 annual report from the Census Bureau on “Income and Poverty in the United States” and points out the very strong correlation between income inequality and household demographics.
The mean number of earners per household increases steadily from a low of .43 in the lowest income households to 2.04 in the top income households.
The marital status of householders. The share of married-couple households is only 17.3% in the bottom income quintile and then increases steadily to 76.5% for the top income quintile.
The age of householders. In the lowest income quintile only 42.4% of households included individuals in the prime earning years of ages 35-64, while 69.9% of households in the top quintile include individuals in this group.
The work status of householders. Only 18% of the lowest earning quintile households included an adult who was working full time, as compared to 77.7% of top earning households.
The education of householders. Only 14.6% of lowest earning households had a family member with a college degree and this percentage rose steadily to 64% for top earning households.
Conclusion. Household demographics are very highly correlated with household income. Specifically, high-income households have a greater average number of income-earners than households in the lower-income quintiles. Individuals in high-income quintiles are far more likely to be well-educated, married, working full-time and in their prime working years. It is also true that individuals and households can and do move up and down the income quintiles as these key demographic variables change.
U.S. healthcare policy is now in limbo. The Affordable Care Act has withstood Congressional attempts to repeal it, but it has many flaws which need to be repaired. Primarily, the ACA expands access to healthcare in the U.S. (good) but does nothing to control burgeoning costs for both individuals and the federal budget (bad).
One option for both further expansion of access as well as cost control is Bernie Sanders’ single-payer “Medicare for All” plan. A different option is universal catastrophic care for all Americans not already covered by Medicare or Medicaid (including those receiving employer provided health insurance).
A different perspective is provided by an editorial in the New England Journal of Medicine. According to the authors, Eric Schneider and David Squires, the U.S. also faces (in addition to the challenge of much better cost control) several performance challenges such as:
Lack of access to affordable and comprehensive insurance coverage for too many people.
Relative underinvestment in primary care. Other developed countries have a higher percentage of their professional workforces dedicated to primary rather than specialty care and deliver a wider range of services at first contact.
Administrative inefficiency of the U.S. healthcare system. The solution here is to change our reimbursement systems to use global payments, fee schedules, formularies and defined benefits.
Disparities in the delivery of care. People with low incomes, low educational attainment, and other social and economic challenges face greater health risks and thus need even greater access to primary healthcare.
Conclusion. The U.S. compares poorly with other advanced countries in both the quality and cost efficiency of its healthcare system. Healthcare costs in the U.S, are a huge drain on the economy and will ultimately cause huge fiscal problems if not brought under much greater control.