With the presidency and both houses of Congress in their grasp, Republicans have a rare opportunity to make policy reforms. So far, nothing major has been done. On health care, the GOP failed to advance legislation. Now attention is turning to tax reform. Let’s hope the fact that taxes aren’t as much of a hot-button issue as health care will lead to something getting done, because the Republican plan contains some pretty sensible stuff.
When most people think about taxes, they think about what economists refer to as distribution -- who pays more, who pays less and who reaps the benefits. Distribution is obviously incredibly important, but economists generally feel uncomfortable weighing in on it, because there’s a moral element to deciding who should get what. Instead of taking sides, they like to focus on efficiency - growing the pie so that politicians have more to distribute in the first place.
In terms of efficiency, income tax cuts have been a bust in recent decades, both at the federal and the state level. Shifting the tax burden from the middle and working class to the rich -- perhaps through payroll-tax cuts coupled with income tax hikes -- would probably have a more noticeable effect on growth. Interestingly, various GOP plans would reportedly eliminate state income tax deductibility and mostly eliminate the carried interest tax break, both of which would represent tax hikes for the wealthy. But so far there’s no talk of cutting payroll taxes, which would be a good way to ease the burden on the middle and working classes.
More important than income taxes would be corporate tax reform. Fortunately, that’s exactly what’s now on the table. Politico’s Nancy Cook reports on some of the changes under consideration, and most look pretty good.
One item is corporate tax cuts. This might make some liberals angry, because corporations seem like big faceless entities owned by rich people, and therefore deserving of high taxation. But there are much better ways to tax the rich. The main reason corporate taxes are so inefficient is that companies are really good at finding ways around them. The U.S. corporate tax rate is 35 percent, but the actual amount of profit that makes its way into government coffers is more like 25 percent:
The Republican proposal would reportedly cut the rate to between 22 percent and 25 percent. If paired with loophole closures, that wouldn’t bring down revenue too much. And it would save companies a lot of money on legal tax avoidance. It might even provide an incentive for U.S. companies to stop relocating their headquarters offshore to lower-tax countries, or stop holding so much cash overseas. Overall, a corporate tax cut would encourage investment, increasing growth a bit.
Another good idea in the GOP plan is to make interest payments taxable. This would have to be phased in slowly, to avoid making heavily indebted businesses go bankrupt all at once. And some businesses’ debts would probably have to be grandfathered in for the same reason. But making interest taxable would give companies an incentive to finance themselves more with equity and less with debt, making the economy more stable. It would also close an important loophole in the corporate tax, offsetting some of the revenue losses from the lower statutory rate.
A third good idea is full expensing of capital investments for small businesses. This policy is similar to accelerated depreciation, which allows businesses to get tax breaks on their investments sooner. Accelerated depreciation has been shown to capital spending, so full expensing should do the same. Though this would represent an expanded loophole in the tax code, the chance to raise business investment is worth it. Targeting the tax break toward small businesses - if this could be done without big companies starting their own small companies to game the system - would help new entrants break into existing industries at a time when established players are becoming more concentrated and startup rates are falling.
So there’s much to like in the wonky GOP tax plan. But we also have to acknowledge political reality: It seems unlikely that much, if any, of this will ever become law. Ending the mortgage-interest deduction, state income-tax deductions, and the carried-interest tax break would all take money away from the well-off - a traditional Republican constituency, not to mention the source of lots of GOP campaign donations.
And many powerful and well-connected companies will fight to keep interest payments tax deductible. Meanwhile, Democrats will probably oppose any effort to lower the corporate income tax.
So economists shouldn’t celebrate yet. They may care about growth, but in the real world, politics rules the day.