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What Congress Should Do On Tax Reform Versus What It Likely Will


It seems the “recovery summer” President Barack Obama and Vice President Joe Biden declared back in 2010 finally arrived in 2017, and is finally wrapping up.

Even historically dovish Federal Reserve Chair Janet Yellen has started talking bullishly about the state of the economy. That is, enough for the Fed to be on the verge of finally tackling its $4.5 trillion balance sheet (consisting largely of mortgage-backed securities and Treasury bonds amassed after the financial crisis)—likely to be approved at their September meeting—and to have already raised interest rates twice this year, with a third targeted for December.

The rate of economic growth for the first quarter of 2017, beginning with Obama and ending with President Donald Trump, was a weak 1.4 percent. But that number more than doubled to 3.0 percent in the second quarter, and the Atlanta Federal Reserve recently projected a 3.4 percent growth rate for the third quarter.

How about job creation? In the first six full months under Trump (February through July), the economy created 1.07 million jobs and the unemployment rate hit 4.3 percent, the lowest in 16 years. In addition to historic lows in unemployment, more people ages 25-54 (prime working years) are employed than at any time since September 2008. What’s more, only 66 out of every 10,000 individuals in the workforce are being laid off each month—the lowest number on record since the metric was established in 1967.

Yet things aren’t where they need to be. To continue the progress we have seen during the Trump presidency so far, it is essential that the president’s pro-growth policies continue and expand. His regulatory steps have been singularly effective; the White House claims that as many as 16 pieces of red tape have been cut for every new regulation. Congress has used the Congressional Review Act an unprecedented 14 times to unwind certain regulations.

But Republicans in Congress and the president must build upon this momentum by taking an ax to the tax code. With the highest corporate income tax rate in the industrialized world, profits held overseas at record highs (above $2.5 trillion) and other discouraging tax burdens placed upon businesses and individuals, it’s essential that Republicans succeed in some form of tax reform—or, at the very least, tax rate cuts. There is a distinction between the two. It’s an important one.

Tax Reform versus Tax Rate Cuts

Tax reform lowers the burden on taxpayers by both slicing rates and reducing brackets; it does not simply cut rates. Tax reform simplifies the code by eliminating deductions and loopholes, limiting double taxation and increasing neutral treatment; it does not add to its complexity or contribute to government’s propensity to pick winners and losers. Tax reform broadens the base, meaning that more Americans have some skin in the game; it does not maintain the status quo. Finally, tax reform promotes a territorial system; it does not discourage repatriation of (bringing home) profits from overseas.

Tax reform, therefore, is not 2001 or 2003. Although the so-called “Bush tax cuts” were targeted, pro-growth policies, they simply consisted of tax rate cuts and tax rebates, hence part of the reason for these policies’ muted effect. There was no real reform—no reductions in the number of brackets, no wide-scale elimination of deductions and loopholes, no broadening of the tax base and no simplification of the code.

Make no mistake: tax rate cuts are vastly better than keeping the status quo. But let’s not confuse them with real tax reform, lest we undercut meaningful reform in the future.

Whereas tax rate cuts are likely to come about regardless, meaningful tax reform is not. This is because of the numerous political incentives that discourage simplifying a 75,000-page tax code that is 187 times its length a century ago. It is riddled with dozens upon dozens of deductions, exemptions and exclusions that contribute to its length and complexity. Many of these deductions are sacred cows that will almost assuredly never go away.

These Two Carveouts Are Bad for Your Tax Rates

Let’s just take two of the prominent ones: mortgage interest and state and local tax deductions. A recent paper for the National Bureau of Economic Research, written in part by Obamacare architect Jonathan Gruber, concluded that the mortgage interest deduction encourages taxpayers to buy bigger, more expensive homes—not to purchase a home in the first place. Further research from the Reason Foundation finds that this deduction primarily benefits wealthier taxpayers making $100,000 or above. Yet despite the compelling case against the mortgage interest deduction, not even President Trump’s tax proposal would get rid of it.

Also consider the state and local tax deduction. Far more people agree that this tax break is distortive, as it benefits residents of larger states far more than those of smaller states. The president proposed cutting off this deduction, yet how many Republicans (let alone Democrats) from New York, California, and other big states will jump on board?

Of course, the whole point of tax reform is to eliminate most or all of these breaks to make it possible to reduce the number of brackets and cut rates. Yet the political arguments against their elimination make it all the less likely that meaningful simplification of the tax code will take place. How many politicians will want to go back home to their constituents—or even worse, those who bankroll their campaigns—and say they voted to eliminate a deduction or exemption those same individuals cherish? Is there really the will to do this in Washington these days?

This Is Why Congress Probably Will Do Nothing Serious

With all due respect to President Trump, the idea that real tax reform is “easier” to accomplish than health-care reform is a ludicrous proposition. Analysts I talk to from across the spectrum agree with this assessment. What is doable, however, are some tax rate cuts. Unless something special is in the works that we don’t know about, that is probably the base from which Congress should start.

Economist Stephen Moore recently suggested on my radio show that Congress focus on three main tax objectives: slicing the corporate tax rate to 15 or 20 percent, permitting the immediate expensing of capital purchases, and encouraging repatriation of profits.

Note that these steps are not tax reform, but just tax relief. One problem with doing only these three things is a political one. It suggests that Republicans only support the “greedy corporations,” to the exclusion of middle-class folks. This is untrue, as it is pro-growth and encourages wage growth and job creation, but it is the persuasive counterargument.

In addition to the above, Republicans should at a minimum call for at least 5 percent reductions in every individual income tax bracket, and/or double the standard deduction, as President Trump proposes, and eliminate the onerous alternative minimum tax, which crushes many middle-class taxpayers.

In my August 2 interview with Colorado Sen. Cory Gardner, a member of Senate Republican leadership, he conceded that tax reform is highly unlikely. His hope, he said, is that some tax relief would come first, followed by tax reform later. This is politician speak for “not gonna happen.”

And that’s okay. So long as we’re clear-eyed about the distinction between tax reform and tax rate cuts, we don’t allow our expectations to rip away at us and businesses and individuals receive some tax relief. That, after all, is the minimum this economy needs to pick up more steam and really get the economic gears rolling again.