The House Republican tax plan does more than I expected to eliminate or reduce credits and deductions.
It would take a productive stride toward broadening the income tax base. That’s important and shouldn’t be dismissed.
Still, the overall design contains fundamental flaws, economically and politically. Basically, it’s a huge tax cut for corporations and the owners of some small businesses, sneaking in under the cover of an overhyped cut for the middle class.
Here are three large reservations.
1: Tax rates are still too high
First, the individual income tax would become even more progressive and growth-oriented tax reforms even more difficult to enact in the future.
President Trump and GOP congressional leaders prattle endlessly about a middle-class tax cut. But the middle class isn’t paying much in the way of federal income taxes to begin with.
The top 10% of income earners pay more than 70% of federal income taxes. Those in the middle quintile of earners pay less than 3% of their income to the federal government in income taxes.
Having such a top-heavy tax base isn’t healthy for a democracy. And it is inimical to the Republican goal of restraining the growth of government. If a larger government doesn’t cost most voters very much, the case against it is harder to make.
It’s clear that Trump and GOP congressional leaders didn’t want to take on the Democratic argument about tax cuts for the wealthy. So, marginal individual income tax rates were left unproductively high.
If the income tax base is broadened but the marginal rates left high, the opportunity to lower them in the future has been foreclosed, both economically and politically.
2: This simplifies nothing for small business
Second, the provision for lower taxes on pass-through profits for some small businesses is unworkable and troublingly complicated.
The main goal of this tax reform effort is to reduce the corporate income tax rate from 35% to 20%.
Many small businesses, however, don’t pay the corporate income tax. They take forms of organization in which the profits are passed through to the owners, who pay taxes on them at their individual income tax rate.
If the top individual tax rates weren’t lowered, small businesses would have been left paying a much higher rate on profits than large corporations. So, the House tax architects concocted a new special tax rate for pass-through profits of 25%.
But for an owner who works for a pass-through business, what constitutes wages as opposed to pass-through profits is pretty arbitrary. So the bill puts forth some equally arbitrary formulas.
Thirty percent of the total income a working owner receives is designated a return on capital and subject to the lower 25% rate. Or the business can come up with an alternative based upon somehow calculating actual capital invested and multiplying that by a rate of return dictated by the government. But, if an alternative is chosen, the business has to stick with it for five years.
Tax simplification for small business this ain’t.
3: It still wouldn't shrink the deficit
And third, the debt and deficits.
On a static basis, the House tax plan adds $1.5 trillion to the national debt over 10 years. The proponents claim that if annual growth were to perk up to 3% a year, over the current roughly 2%, that would disappear.
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There would be more confidence in that result if the bill didn’t effectively put a fork in pro-growth reductions in individual marginal tax rates. But, at this point in the country’s fiscal history, just not making things worse isn’t good enough.
Disappointingly and frustratingly, there was a better blueprint available. The Simpson-Bowles commission, appointed and ignored by former president Barack Obama, developed a plan that reduced both the corporate and individual top tax rate to below 30% while producing more money for the federal government to actually reduce the annual deficit and stabilize the country’s sovereign debt.
That’s what true tax reform would look like.