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Equity and Efficiency

eye on the news

Equity and Efficiency

The GOP’s proposed tax reforms are imperfect but deserve support. November 13, 2017
Politics and law
Economy, finance, and budgets

Criticism of recent Republican tax-reform proposals seems to have emerged from every quarter. Some fiscal hawks worry over deficits, while every interest group that sees a threat to its perks has raised objections. But in seeking to cut back on deductions and credits and use the resulting tax collections to reduce statutory rates, today’s proposals reflect the same spirit as reforms put forward from both sides of the aisle over the years—including the great bipartisan reforms of the 1980s, under President Ronald Reagan. It was also the prescription made by President Barack Obama’s 2010 National Committee on Fiscal Responsibility, known colloquially as Simpson-Bowles, after its leadership.

The reasoning behind all these past reform efforts, and today’s proposals, is that the changes would create both greater equity and economic efficiency. Closing loopholes would force those using the breaks henceforth to pay their fair share, even as it would relieve other taxpayers of the need to make up the difference. Ridding the code of complexity would improve growth prospects by clarifying the tax consequences of any action and by inducing people and businesses to make decisions for economic reasons instead of the political preferences built into the code. The general reduction in statutory rates would further enhance growth prospects by encouraging individuals to work and businesses to invest more for the future. Lower statutory corporate rates would offer still another benefit by encouraging U.S. companies to repatriate the accumulated earnings they hold overseas, giving the economy a welcome cash infusion for investment.

Though real-estate agents and construction companies see a threat in the provision to allow mortgage-interest deductions only on loans up to $500,000, such a move would hardly harm the economy. Canada and other countries allow no such deduction and have higher homeownership rates than the United States. Capping the deductibility of interest on home loans would be more equitable, since only the wealthiest Americans use the full extent of the benefit, while the change would not affect smaller homeowners or renters. Limiting the deduction that businesses can take on interest expenses has only vague implications for equity, but it would improve economic efficiency by removing the current code’s economically unjustifiable tendency to force business to rely heavily on debt instead of equity financing.

Even the proposed elimination of the estate tax, though it seems to favor the very wealthy, has positive implications for economic fairness. The burden of the current code falls mostly on the middling rich—those who inherit family farms or small businesses, and who frequently have to sell off their inheritance just to pay the tax. Meanwhile, the very rich, many of whom support high estate taxes, protect their heirs by giving their money, tax-free, to charitable family foundations, where they see to it that their descendants have comfortable positions, with sometimes lavish benefits. They ensure that the benefits of their wealth pass from one generation to the next, free of tax penalties.

These same matters of equity and economic efficiency even support the proposal to eliminate any write-offs for state and local taxes, except for $10,000 of property taxes.  The state and local tax (SALT) deduction is a matter of high anxiety among residents of New York, New Jersey, California, and a few other high-tax states, whose leaders accuse Trump and Republicans of punishing Blue states. Whatever Trump’s political motivations, the current system is unfair. Because SALT deductions reduce federal tax revenue from a few states, the Treasury makes up the difference by taxing all Americans at higher statutory rates, effectively subsidizing political decisions made in Albany, Sacramento, and Trenton. If people in these states want a tax break, they should consult their own politicians, instead of asking the federal government to help out—not least because the rest of the country gets no say in the process.

The proposals aren’t perfect, but they are a step in the right direction. For the economic purist, every practical proposal has points of dispute. The current proposal to lower rates for each new individual tax bracket—except the highest—suggests a pointless compromise with the redistributionists. It is not that the very richest people need a tax break, but this aspect of the reform will promote wasteful efforts at tax avoidance among decision-makers, get no Democratic votes, and blunt the economic boost that a general cut would bring. The proposal’s increase in the child tax credit passes economic muster, but the decision to apply it to the higher band of the income spectrum forces the framers to satisfy deficit hawks by searching for revenue elsewhere, where it might have more economically distorting effects. The phase-in of estate-tax reductions seems unfair to those whose benefactors die at inconvenient times; it will promote wasteful maneuvering in the interim. 

The nature of the debate will become clearer as the process plays out in the House and then in the Senate, but these admittedly imperfect reforms deserve support. Whether the final legislation reduces taxes or is revenue-neutral, even partial success at cutting complicated breaks and reducing statutory rates would boost the economy and make the system fairer. The elimination of special breaks and credits in the tax code could even restore citizens’ faith in Washington by lifting, if only in part, the prevailing sense that the system is rigged for a favored few.        

Photo by Drew Angerer/Getty Images

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