Tax Reform, Revisited: The Good, the Bad and the Ugly
History often seems to repeat itself. Once again, the latest Republican Obamacare replacement plan has failed to pass (although there's some progress) and the Republicans in Congress are now looking into a seemingly much easier policy decision: an overhaul of the tax code.
While I have already discussed tax reform, due to changes on the topic since then, it is logical to take another look at the unfolding tax reform proposal.
The proposal is of course still in flux - indeed, Speaker Ryan has proposed Congress work through Christmas to finalize it - but it’s worth taking a look at to see how it is shaping up.
First, we should consider the positives of the proposal. The proposal lowers rates in both personal income and corporate taxes. Personal income taxes would be reduced to three brackets of 12%, 25 and 35%.
Meanwhile, the corporate tax rate would drop to 20% from 35%. Given the US corporate tax rate is the highest rate in the Western World, lowering it is important to ensuring the US economy is competitive. The tax plan would also increase GDP greatly over in the near future according to 60% of economists surveyed on the question. It is very clear that the core elements of this proposal would boost economic growth. This would vindicate the stock market boost arising from the likelihood of this proposal being enacted.
However, there are several significant flaws in the current proposal. Economically speaking, the proposal is certainly not revenue-neutral: it would increase deficits by some $2 trillion. While some argue that it will offset this via economic growth, this is a risky proposition to bet on, especially due to the costs of higher deficits. Failing to offset the reduced tax revenues with spending cuts will threaten the country’s economic health.
There are additionally flaws politically speaking that could threaten this plan. Most notably, the current tax proposal would eliminate deductions for state income taxes. While this is not a huge deal for individuals in places like Texas or New Hampshire, this would be an issue for high-taxed states like New Jersey or California.
Removing this deduction would mean many individuals in these states would see a tax increase, especially for members of the upper-middle class. This clearly is a major problem for those seeking reductions in taxes and encouraging economic growth.
While some have argued that this would encourage states to lower taxes, this part of the proposal is easily the most damaging and threatens to offset the gains from the proposal, at least in the view of the public at large (and certain Republicans in office). It is little wonder that many individuals involved in drafting the proposal have reconsidered this aspect of the plan.
Overall, there is a lot to like in the current Republican tax reform proposal. The problems are clearly there, but there is a good chance they will be solved before the proposal is actually scheduled to be voted on.
Tax reform is essential to ensuring the health of our economy as well as to the future of the Republican-controlled legislative branch.
It is very important that Republicans in Congress work to improve the bill as much as possible, given the unlikelihood of the proposal as it stands today being passed. With some key revisions (such as keeping at least part of the state income tax deduction), this bill would be politically profitable as well as economically.