Jeb Bush’s tax reform plan: Good for the taxpayer and the economy

Jeb Bush presented his tax reform plan to the Wall Street Journal yesterday. The Weekly Standard has some of the details.

In a return to what Bush called the structure of Ronald Reagan’s 1986 tax reform, the three tax brackets would be set at 10, 25, and 28 percent. The standard deduction would also be nearly double its current levels, including an added $5000 for individual filers and an added $10,000 for married filers. The Bush campaign says these changes will give 42 million “middle-class” Americans a 33-percent reduction in their tax liability.

It’s a tax cut for middle-class families, yes, but also for the wealthiest Americans. The current top tax bracket is 39.6 percent, meaning top earners would see a drop in their tax rate by more than 10 percentage points. But, the Bush campaign points out, the proposal also caps itemized deductions (except for charitable contributions) to two percent of adjusted gross income, which would likely reduce the overall affect of the significant rate decrease.

On corporate taxes, Bush plans to eliminate deductions on corporate borrowings but add deductions for capital investment, “something which will help businesses buy equipment, build factories and invest in other growth.”

“If your business model depends on heavy debt and leverage, that’s your choice. Under my plan, you’ll pay for it,” Bush said. The plan also eliminates the “worldwide” taxation regime that forces American companies operating overseas to pay U.S. corporate rates in addition to the rates they pay in the country of operation.

Bush called his proposal a “radical change to our tax code,” but there are few radical notions in the plan. One notable departureis his call to close the carried-interest loophole in the code, whereby private-equity and hedge-fund managers who are paid commission as a share of the investments they manage pay the lower capital-gains rates on those commissions. Bush has proposed that money be taxed at income-tax rates instead, raising the effective rate from 23.8 percent to 28 percent.

The lower tax brackets will certainly be cheered by supply-siders (such as myself), and the reduction to 28% will be large enough to have a positive impact on growth. I also like the deduction cap. It’s more efficient and less cumbersome than the Alternative Minimum Tax (which keeps drawing in more and more taxpayers far below the ultra-rich income levels that were supposed to be ensnared by it), while preserving the idea of minimizing tax avoidance. I’m also intrigued by the corporate deduction changes, which encourages businesses to invest in themselves but discourages borrowing to do it. A critical factor in the Panic of 2008 was the funny business with the LIBOR rate, upon which most major corporations relied to determine borrowing cost and availability. If businesses had been less debt-leveraged in the first place, the effect might not have been as dramatic.

As for closing the carried-interest loophole, I’m not a fan. It was cheap populism when Donald Trump called for it, and it still is. It’s effect on the economy should be small, and will likely just mean private-equity and hedge-fund managers will shy away from an investment share in their commission. Still, there is risk in investment, and lower capital gains rates take that risk into account. Ignoring the risk because you don’t like the risk-takers is folly.

An analysis by four center-right economists (Center for Global Enterprise) has more specifics, for those of you who share my interest in it.

A doubling of the Earned Income Tax Credit for workers who don’t have children, which “will effectively mean childless workers will benefit from a zero marginal tax rate when entering the workforce.” If anything, I would have also upped the EITC for workers with children, but this is still a step in the right direction. The nature of American welfare benefits can actually give poor people an incentive not to work. An EITC increase reduces (and the economists claim it eliminates) that perverse incentive, and very rightly so.

Lowering the Capital Gains tax rate to 20%. This is another supply-side favorite, because it encourages investment. It also usually increases government revenue.

Allow married couples to file as single taxpayers. This may seem weird, but it effectively wipes out the marriage penalty, by allowing married couples who could lower their tax bill if they were single to reap those benefits and keep (or get) the ring.

Reducing the payroll tax for workers already at retirement age. Given that Social Security will likely need serious reform soon (albeit, not immediately, but soon), this make some sense. Social Security is really a generational transfer: no one pays for their own (if they ever did), but actually pays for their parents. Older Americans, who will likely receive less anyway in the future, really shouldn’t be asked to keep paying as much as they do.

Eliminating the State and Local sales tax deduction. This is a deduction whose time has come and gone. It gives tax-and-spend states and localities some cover for their damaging policies, when they should have none.

All in all, these are good plans, plans which would increase economic growth. However, as the economists note, they are not “revenue neutral.” Now, the economists use two figure for budget impact. The “static” scoring would show a loss of $340 billion in revenue annually, but they (and I) prefer dynamic scoring (which takes the effect of the policy into account), and come up with $120 billion in annual revenue loss.

Even that has caveats, though: it relies on economic growth not just from the tax cuts (0.5% more than without them per year), but “the Governor’s regulatory reforms” – which are not spelled out here. I would have rather seen just a tax-effect dynamic number. As it is, I have to guess, and given that the regulatory reforms are supposed to add about 0.3% a year to growth, that would make my guess about $200 billion a year in annual revenue loss.

The economists note that such a gap can be reduced.

During the past seven years, we have observed a lack of budget discipline. The result: a rapid surge in federal expenditures unprecedented outside of wartime. Although some spending increases were expected during the economic recession, federal outlays have failed to decline since the recession’s end five years ago. Today, the federal government’s annual spending is one trillion dollars more than it was in 2007, the year before the recession began. The spending surge has been fueled largely by a 49 percent increase in domestic spending. The increase has coincided with economically damaging higher tax rates, higher national debt, and a weakened national defense.

Certainly, in light of the one trillion dollars that has been added to annual federal spending since 2007, the existing budget base should not be sacrosanct. Setting the budget base aside, the required budget goal can be achieved by reducing the growth in federal outlays from its current upward trajectory by one percentage point per year. From 2017 to 2025, federal expenditures are projected to increase at an annual rate of 4.2 percent. Limiting the increase to 3.2 percent will produce over $400 billion in budget savings in 2025 and $1.4 trillion in savings between 2017 and 2025. Achieving this limit would still entail federal program spending to increase by 40 percent above its current level, rather than by its currently projected 50 percent.

Sounds easy, right?

Only that’s the problem, “budget discipline” always sounds easy, and with a little political will it can be easy, but that doesn’t mean it gets done. Between 2001 and 2006, economic conservatives watched with horror as a Republican President and a (mostly) Republican Congress enacted budgets that increased spending by more than 7% a year in nominal dollars on average (over 4% in real dollars) – and as the Cato Institute noted in 2003, it wasn’t just about defense spending.

So, while Bush’s tax policies themselves are very good, they will need help from the rest of Bush’s agenda to fully realize the benefits claimed. If Bush does get to the White House (and I would still consider that a very large “if”), he may rue that oversell.

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