It’s hard to know what to say about the Republican effort to pass “tax reform.” It’s a rush. It’s a mess. And nobody knows how it is all going to fit together. Plus the Republicans are doing it all by themselves without any input from the other side. In other words, it sounds a lot like Obamacare. Which means all of the Democratic complaints about process and procedure are just partisan hoo-ha, as opposed to serious, principled arguments. Except for any such complaints coming from Democrats who have sincerely apologized for how they passed Obamacare and credibly promised to not do it again when they get back in power, the number of which is, as far as I can tell, about one less than the number of World Series the Chicago Cubs have won in the last 108 years.
So what is there to say about the Republican effort to pass “tax reform”? The first thing is that tax reform does not always mean everyone’s taxes go down. Real tax reform means moving to a better tax system.
On that basis, our current tax system is a mess. Special interest deductions and credits fill the tax code like a Christmas tree on steroids.1 In 1986 Ronald Reagan, et al, simplified the tax system by eliminating a number of deductions and credits. By broadening the tax base, they were able to lower the rates – for everybody. Since 1986, complexity has crept back into the system, and rates have gone back up. Deductions here; credits there; special little taxes everywhere. It’s complicated and expensive to comply with. It encourages people to do things, for tax reasons, that they wouldn’t otherwise do. And it doesn’t provide enough money to pay our bills.
With respect to our highest-in-the-OCED corporate tax, Barack Obama said he was in favor of reforming it, but he never got around to presenting any detailed proposals. Also, he made it clear that, if tax reform didn’t wind up providing more money for the government to spend, he wouldn’t do it. A better system that raised the same amount of taxes wasn’t something he was interested in. So, nothing happened.
Republicans are now trying to do something. Real “tax reform” would be great, but neither the House nor the Senate plan, nor any likely compromise plan, meets the standards listed above. They are too complicated, with too many deductions/credits and too much recordkeeping and compliance requirement.
But that is probably not a realistic test in this hyper-partisan time. There are really two main questions. First, are they better than what we have now? Second, do they avoid setting up new obstacles on the way to a good system?
While I have not looked at the business side in detail, the main idea, to get our tax rates more in line with those systems in other countries, is a good one. We may not like it, but having a tax rate higher than other countries does affect businesses’ decisions. A lower rate is a move in the right direction, and I hope that some of the stupid deductions and credits will be cut back.
One thing is to make sure whatever changes are made will be permanent; i.e., they will not be changed in two or four years or expire at the end of some arbitrary period. A tax system that is supposed to encourage business investment and growth needs to be around a while. A company isn’t going to build a plant or hire new employees if the tax code is going to change in two years. Certainty and consistency is what business needs if we want it to invest and grow.
On the personal tax side, the Republican plans have some good things. Eliminating deductions and increasing the standard deduction is a step in the direction of a simpler tax system. I am not enthusiastic about increasing the child credit (it will be hard to change in the future), and I don’t like all the phase-out rules for some of the deductions and credits that are being kept. If the purpose is to “get” the rich (not a purpose I am in favor of but which seems to be politically popular), do it in the rate, not in the complexity that comes from phase-out rules.
A special comment needs to be made on the Republican proposal to eliminate the deduction for state and local taxes and the rather hysterical response to this proposal by the Democrats.2 Normally, Democrats don’t like deductions that favor the rich, which this one does in spades. Not only, according to normal Democratic theory, does this deduction help those whose tax higher is higher (if your rate is 39.6%, a $1,000 deduction saves you $396, while if your rate is 15%, a $1,000 deduction only saves you $150), but the rich also have a higher amount to deduct. So they get favored twice. For example, a middle income person might get a $5,000 deduction at a 20% rate, which is worth $1,000. A person paying $50,000 in state and local taxes, and paying federal income tax at the 39.6% rate, gets a tax reduction of $19,800. Most times Democrats would be screaming about how unfair this is to the middle class. Here they are not.
One other comment needs to be made: On the fact the Republican plan will, apparently, result in an increase in the deficit and the debt. This is not good. We need to start getting the deficit and the debt under control. My preference would be a real tax reform plan that was at least revenue neutral, if not actually generating additional taxes, so that the deficit and debt could start to move down. I would be more impressed by Democratic complaints about this, however, if they carried their concern about our future financial stability over to social security or some of their plans for things like Medicare-for-all. Their concern about the deficit in this case seems to be more of a matter of using whatever stick is available as opposed to a principled position.
So, how does the Republican plan stack up? I don’t know. There are real concerns: the potential impact on the debt; the rush with which it is being passed; the fact we don’t know how it’s all going to fit together; the potential unintended consequences being pretty much off the charts. But it is entirely possible that the consequences of not passing it may be worse than passing it. The Democrats certainly felt that way about Obamacare.
1 The definition of a “special interest” deduction or credit is one somebody else takes.
2 See also here and here.