Commentary Type

Tax Reform Should Not Make Other Problems Worse

Jason Furman (PIIE)


My dream for tax reform is that it would help us to tackle some of the biggest challenges we face: a growth rate that is too slow, inequality that is too high, and rising public debt—not to mention climate change.

Tax reform could raise more revenue than it does today and do it more progressively and efficiently. That would entail raising revenue from higher-income households, increasing the reward to work for lower-income households, shifting to taxing harmful activities like the production of carbon, and reforming the business tax system to move it toward a cash flow tax with lower rates and capital taxed more at the individual level than at the corporate level.

I recognize that my dream currently falls short of 218 votes in the House and 50 votes in the Senate. So I would be willing to downgrade to a more minimalist hope: that tax reform does not make any of these problems worse.

This hope ought not be too much of a stretch. It was the premise of the reform by President Reagan and the Democratic Congress in 1986—specifically that reform satisfy both revenue and distributional neutrality. In fact, the argument for this premise is even stronger today than it was in 1986. The debt held by the public is 77 percent of GDP today, significantly higher than the 38 percent of GDP in 1986. And the share of income going to the bottom 90 percent of Americans has fallen from 64 percent in 1986 to 53 percent today.

It is possible to design an effective tax reform plan that honors Reagan's principals and also strengthens economic growth, benefiting all Americans. In fact, the converse may not be possible—if tax reform dramatically increases deficits or worsens inequality, it could be counterproductive for economic growth. Economic modeling has consistently shown that, over time, the costs of higher deficits outweigh any benefits of lower rates or other tax changes.

The largest effects of individual tax reform are on the level and distribution of revenue. There is some additional economic efficiency that could be gained by reforming individual taxes, but the gains are not large and the efficiencies are politically controversial—members of Congress are almost as united in their support for the mortgage interest deduction as economists are united in their opposition to it. Progress in an economically productive direction is more likely if we save individual tax reform for a future date and instead focus on the business side.

Business taxation matters more for growth because corporations do not make decisions about where to locate and where to invest in a vacuum; instead, they are comparing their opportunities in the United States with opportunities in other countries—both the economics and the tax implications. The statutory US corporate rate is the highest of any of the advanced economies. At the same time, numerous loopholes and features of the tax code allow too many companies to pay little or nothing in the way of taxes. The epitome of this disconnect is manifested in the taxation of overseas earnings, where we impose a very high rate in theory but in practice do not collect anything at all.

All of these problems have something in common: they can be solved without raising the deficit or increasing inequality.

This could be done by drawing on elements of the plans put forward by congressional Democrats and the House Republican Better Way plan. That would include:

  • lowering the corporate rate as far as we can consistent with revenue neutrality, which could be to 28 percent if extra measures like a tax on large and risky banks were thrown into the mix;
  • shifting to a cash flow tax by allowing businesses to expense their next investments and deduct their interest;
  • establishing a minimum tax on foreign income together with free repatriation of earnings; and
  • using any transitional revenue gained through reform to make a one-time investment in infrastructure.

The conservative approach to such a tax reform would be to eschew dynamic scoring—consistent with the way tax reform was treated in the president's budget, according to Office of Management and Budget (OMB) Director Mick Mulvaney. It is likely that the tax reform I described would raise growth and boost revenue, helping with our deficit—not a bad surprise to face. But using dynamic scores as long as they are done by the nonpartisan scorekeepers at the Congressional Budget Office and the Joint Committee on Taxation would also be reasonable and not hugely different from past scorekeeping conventions. It would be a major economic mistake to dramatically break from precedent and simply assume a growth rate or dynamic score, something that would make it likely that we would end up disappointed with subpar growth and larger deficits.

If we set aside the ideological issues of revenue levels and distribution, there is no reason we could not reach agreement on a meaningful tax reform. Absent that, it is likely that any tax changes they will be temporary tax cuts, which would both increase the deficit and increase economic uncertainty, making our major challenges in terms of growth, inequality, and the fiscal outlook even more challenging.

More From

More on This Topic

Related Topics