I asked readers what tax reform plan they would recommend to President Obama and Congress. Most readers were pessimistic, with liberals convinced the Republicans would deny the president a “win” on this issue.
Coffeetime (echoing Jon Huntsman’s view) had this to say:
Money talks. Behind every tax exemption sits underlying votes and/or campaign contributions. You say you want to disallow mortgage deductions for second homes? You will be fighting the real estate industry, builders, plus RV and boat manufacturers. Perhaps something like the CBO would be needed to “score” all of the various exemptions in the tax law. That way, the Dems could offer to give up exemption Y but the GOP would have to give up exemption Z that was at least equal to Y.
Either that, or the two sides would just reckon that both sides up to now have an equal stake in simplifying the tax code, and do away with ALL exemptions. That’s got my vote.
There is an intuitive appeal for this approach. Indeed the Wall Street Journal editorial board raved about Huntsman’s plan, declaring it, “Better than anything so far from the GOP Presidential field.” And Jim Pethokoukis of Reuters wrote:
Basically, this is the “zero option” Bowles-Simpson tax plan that lowers marginal tax rates and broadens the tax base. But there is at least one big difference. B-S would use part of the money from axing some $1 trillion in annual tax breaks to lower marginal rates and part for deficit reduction — a net tax hike. Huntsman would divert that extra tax revenue into “paying for” the elimination of investment taxes.
At first glance, this looks like perhaps the most pro-growth, pro-market (and anti-crony capitalist) tax plan put forward by a major U.S. president candidate since Ronald Reagan in 1980. But it is not without political risk. In addition to killing tax breaks for businesses, Huntsman would eliminate the mortgage interest deduction, healthcare exclusion, and the child tax credit among other “tax expenditures.” We’re talking about a whole herd of sacred cows. Both his fellow presidential candidates and Washington lobbyists will likely attack him for some of those ideas.
And that is the rub. For middle-class, home-owning families, the tax bite could be very big.
A less radical and more family-friendly plan is that set forth by Rep. Paul Ryan (R-Wis.):
Reject the President’s call to raise taxes. Instead, keep overall revenue as a share of the economy at historical averages between 18 and 19 percent, a level compatible with growth, and — if the spending restraints in this budget are enacted — sufficient to fund government operations over time.
Reform the tax code by consolidating the current six brackets and cutting the top individual rate from 35 percent to 25 percent.
Broaden the tax base to keep revenue as a share of the economy at levels sufficient to fund critical missions that rightly belong in the domain of the federal government (as outlined elsewhere in this budget).
On the corporate tax side, he recommends:
Encourage economic growth and job creation by lowering the corporate tax rate from 35 percent, which is the highest in the developed world, to a much more competitive 25 percent.
Remove distortions from the code by eliminating or modifying deductions, credits and special carve-outs that leave many companies paying no tax at all.
As for the latter, he explains:
The negative effects of high rates on work, savings and investment are compounded when a large mix of exemptions, deductions and credits are added in. Sometimes referred to as “tax expenditures,” these distortions are similar to government spending — instead of markets directing economic resources to their most efficient uses, the government directs resources to politically favored uses, creating a drag on growth.
The key difference is that, with spending, the government collects the money first in the form of taxes from those who earned it, and reallocates the money elsewhere. With tax expenditures, government agrees not to collect the money as long as it is put to a government-approved use. Other tax expenditures literally do take the form of spending through the tax code, because they “return” more money than the taxes owed.
Tax expenditures have a huge impact on the federal budget, resulting in over $1 trillion in forgone revenue each year (although the exact definition of a “tax expenditure” is subject to debate.) To put that number in perspective, $1 trillion is roughly the total amount the government collects each year in federal income taxes.
Eliminating large tax expenditures would not be for the purpose of increasing total tax revenues. Instead, when offset by lower rates, it would have a doubly positive impact on the economy — it would stop diverting economic resources to less productive uses, while making possible the lower tax rates that provide greater incentives for economic growth.
Ryan leaves many details to the House Ways and Means Committee, which is in charge of drafting tax bills. But the direction seems right: Reduce rates, remove many corporate tax credits and deductions, and keep the total income tax burden at about 19 percent. Unfortunately, that is highly unlikely to happen until we have a president who doesn’t find it irresistible to “tax the rich.”