Yesterday, House Ways and Means Committee Chairman Dave Camp (R-MI) released his long-awaited (at least among budget nerds) tax reform proposal. For those used to dealing with GOP fiscal policy proposals in recent years, it was strangely careful and serious. Yet, this proposal still highlighted the excessive importance policymakers attach to “tax reform that lowers rates,” which has been a north star of fiscal policy wonks seemingly since the dawn of time. The idea is that lowering rates will spur economic efficiency, but to make up for revenue lost to lower rates, one must broaden the tax base to which the new, lower rates apply.
Lowering income tax rates, however, reduces revenue so much—especially from wealthy individuals and businesses—that it’s mathematically difficult to make up what’s missing without completely gouging the working and middle classes. This is why Republicans have shied away from the details that would make their top-line tax reform goals work. (They are then pilloried, and rightly so, for ignoring mathematical realities.) It’s easy to lower tax rates; it’s hard to then figure out where the money is going to come from to make up for it. And the payoff in terms of increased growth from all this angst is decidedly modest. Under Rep. Camp’s plan, the federal government would lose more than $1.2 trillion over the next ten years from lower tax rates for individuals and businesses, and another $1.4 trillion by repealing the Alternative Minimum Tax. Here are the good and bad of just some of the provisions that make up for the lost revenue:
- An $86.4 billion tax on “systemically important financial institutions.” This is a far cry from the fair and substantial contribution we actually need from the financial sector, but it’s a start.
- A $44.7 billion revenue increase from taxing capital gains as ordinary income, after the first 40 percent. Again, this is a far cry from the convergence between tax rates on wealth versus tax rates from work that the economy needs, but it’s going in the right direction.
- A reduction in the size of a mortgage eligible for the mortgage interest deduction to $500,000 from $1 million.
- A $217.2 billion cut in the Earned Income Tax Credit, which would cost some very low-income recipients $2,000 per year.
- $170.4 billion in increased revenue as a “transition” to a “territorial tax” system that would incentivize off-shoring, and which would lose revenue thereafter. (On the bright side, $126.5 billion of this would be used to shore up the Highway Trust Fund.)
- Many one-time and phased-in provisions that allow the entire package to be revenue neutral over the first decade, but deficit-increasing thereafter. These are accounting gimmicks, plain and simple.
This is a real, flesh-out proposal, not empty rhetoric. It has real winners and losers—costs and benefits that must be weighed. While the forces of the status quo seem to always overvalue the costs over the benefits of policy changes (as in the recent reactions to CBO’s studies on the labor market effect of the Affordable Care Act and of the proposed minimum wage hike), they should instead be carefully considered.
Rep. Camp’s proposal fails the cost-benefit test; the downsides (revenue neutrality in the first decade and revenue decreases thereafter; cuts to the Earned Income Tax Credit; incentivizing corporate offshoring) outweigh the positives (the bank tax, the treatment of capital income). Rep. Camp deserves credit for publicly articulating the trade-offs inherent in tax reform that sets to meet the Republican Party’s rate-lowering, base-broadening, revenue-maintaining objectives. That no one seems to like these trade-offs (Speaker Boehner’s reaction to the proposal: “blah, blah, blah, blah”) says more about the misplaced objectives themselves than about any particular provision.
Further, the amount of economic growth this proposal would stimulate is highly uncertain at best. The Joint Committee on Taxation (JCT) estimates of how much larger GDP could be in 2023 due to this package range from essentially zero (0.1 percent) to 1.5 percent. While 1.5 percent is not nothing, it is an outlier, with the median estimate offered by JCT hovering at just 0.15 percent. To be clear, this means that if growth were to average 2 percent over the next decade in the absence of tax reform, this median estimate argues that it would average 2.15 percent if Rep. Camp’s plan were to be enacted. Given this modest payoff, it is awfully hard to understand why tax reform is seen as a hard-headed growth-seeking strategy while, say, advocating a return to full-employment, which would boost GDP by several multiples of this, is somehow just a liberal special interest.
Finally, searching for “revenue neutral tax reform,” doesn’t make much sense on its face. Meeting priorities such as strengthening the social safety net and improving public infrastructure will demand more revenue going forward. Since we know that a broader tax base actually increases the revenue-maximizing top tax rate (meaning that a broader base and higher rates are complements, not substitutes), our goal shouldn’t be to lower rates and then figure out how to pay for it, but rather to enact real revenue-raising, progressive tax reform.