Some Positive Tax Changes . . . But We Still Need Tax Reform
With the release of the Tax Cuts and Jobs Act (TCJA), the long-awaited tax bill has been released.
The most pro-growth aspects would change the U.S. corporate income tax system. Corporate income taxes have become a large economic disincentive against investing in the U.S. The TCJA reduces the corporate income tax rate to 20 percent, from the current 35 percent, and makes the U.S. corporate income tax system globally competitive once again. These changes will undeniably improve our economic performance and spur greater wage and income growth.
Too bad the same praise does not apply to the personal income tax provisions. Certainly, some of the proposed changes are positive. For example, the federal income tax base has been inefficiently narrowed by special interest deductions, and the elimination of many of these deductions, and a broadening of the tax base, is undoubtedly beneficial.
Take the partial repeal of the state and local tax deduction as an example. Under the current tax system, high tax states, such as California, have been receiving unwarranted benefits for years. Since federal taxes are collected to pay for federally provided public goods and services, there is no justification to allow residents of high tax states to shirk their share of the federal tax burden simply because they or their elected representatives have voted to impose high state and local taxes. From a tax reform perspective, it is important to eliminate these special interest deductions to enable the lowest possible marginal income tax rates.
Unfortunately, not all the proposed changes are beneficial. Some are simply irrelevant. For instance, it is not clear why changing the number of tax brackets from four to seven is beneficial, particularly since the top marginal income tax rate has not been reduced (which, of course, is the purpose of the provisions that broaden the tax base).
Then there are the proposed changes that will, ultimately, work against the goals of tax reform. For instance, the TCJA proposes to increase the child tax credit. Raising the child tax credit does not improve the underlying economic incentives, but it does reduce overall tax revenues. Due to the higher child tax credit proposal, opportunities to further improve the tax system’s efficiency, and further increase economic prosperity, are lost.
Perhaps what is most disappointing of all is the lost opportunity to implement true tax reform. For example, in PRI’s publication “Eureka: How to Fix California”, Dr. Laffer and I suggest a true flat tax reform that would be just as effective for the federal tax system (in fact the California proposal is based on Dr. Laffer’s federal tax reform first proposed in the 1980s).
Under this tax reform, all current taxes levied in the U.S. would be eliminated. The corporate income tax would be gone. So too would the personal income tax, the payroll tax, and every other federal tax. In their stead, two flat rate income taxes would be created – a value added tax (VAT) levied on net business sales, and a personal income tax (PIT). To overcome the problem of the VAT being hidden, statutorily the VAT and PIT should be required to be the same tax rate.
If this tax reform were implemented, then the entire U.S. tax code could be replaced with two simple flat taxes with a tax rate around 11 percent! What’s more, at 11 percent, the proposals would be revenue neutral on a static basis. Put differently, by eliminating the inefficiencies and waste of the current tax system, the same amount of tax revenues can be raised while also incenting faster economic growth. Truly a win-win tax reform, that would be worthy of the effort.
There are other reforms possible that could achieve the same goal (although I am partial to this plan). But, the larger point is that the purpose of tax reform is to radically transform our current anti-growth and overly-complex tax system into a simpler, less burdensome, and more pro-growth tax system.
While some positive changes to the corporate income tax system may be the best we can expect given the circumstances, the TCJA falls short of the benefits that true tax reform could deliver.
Wayne Winegarden, Ph.D. is a Sr. Fellow in Business and Economics at the Pacific Research Institute