In my 2012 primer on fundamental tax reform, I explained that the three biggest warts in the current system.
1. High tax rates that penalize productive behavior.
2. Pervasive double taxation that discourages saving and investment.
3. Corrupt loopholes and cronyism that bribe people to make less productive choices.
These problems all need to be addressed, but I also acknowledged additional concerns with the internal revenue code, such as worldwide taxation and erosion of constitutional freedoms an civil liberties.
In a perfect world, we would shrink government to such a small size that there was no need for any sort of broad-based tax (remember, the United States prospered greatly for most of our history when there was no income tax).
In a good world, we could at least replace the corrupt internal revenue code with a simple and fair flat tax.
In today’s Washington, the best we can hope for is incremental reform.
But some incremental reforms can be very positive, and that’s the best way of describing the “Economic Growth and Family Fairness Tax Reform Plan” unveiled today by Senator Marco Rubio of Florida and Senator Mike Lee of Utah.
The two GOP senators have a column in today’s Wall Street Journal, and you can read a more detailed description of their plan by clicking here.
But here are the relevant details.
What’s wrong with Rubio-Lee
In the interest of fairness, I’ll start with the most disappointing feature of the plan. The top tax rate will be 35 percent, only a few percentage points lower than the 39.6 percent top rate that Obama imposed as a result of the fiscal cliff.
Even more troubling, that 35 percent top tax rate will be imposed on any taxable income above $75,000 for single taxpayers and $150,000 for married taxpayers.
Since the 35 percent and 39.6 percent tax rates currently apply only when income climbs above $400,000, that means a significant number of taxpayers will face higher marginal tax rates.
That’s a very disappointing feature in any tax plan, but it’s especially unfortunate in a proposal put forth my lawmakers who wrote in their WSJ column that they want to “lower rates for families and individuals.”
What’s right with Rubio-Lee
This will be a much longer section because there are several very attractive features of the Rubio-Lee plan.
Some households, for instance, will enjoy lower marginal tax rates under the new bracket structure, particularly if those households have lots of children (there’s a very big child tax credit).
But the really attractive features of the Rubio-Lee plan are those that deal with business taxation, double taxation, and international competitiveness.
Here’s a list of the most pro-growth elements of the plan.
A 25 percent tax rate on all business income – This means that the corporate tax rate is being reduced from 35 percent (the highest in the world), but also that there will be a 25 percent maximum rate on all small businesses that file using Schedule C as part of a 1040 tax return.
Sweeping reductions in double taxation – The Rubio-Lee plans eliminates the capital gains tax, the double tax on dividends, and the second layer of tax on interest.
Full expensing of business investment – The proposal gets rid of punitive “depreciation” rules that force businesses to overstate their income in ways that discourage new business investment.
Territorial taxation – Businesses no longer will have to pay a second layer of tax on income that is earned – and already subject to tax – in other nations.
No death tax – Income should not be subject to yet another layer of tax simply because someone dies. The Rubio-Lee plan eliminates this morally offensive form of double taxation.
In addition, it’s worth noting that the Rubio-Lee plan eliminate the state and local tax deduction, which is a perverse part of the tax code that enables higher taxes in states like New York and California.
Many years ago, while working at the Heritage Foundation, I created a matrix to grade competing tax reform plans. I updated that matrix last year to assess the proposal put forth by Congressman Dave Camp, the former Chairman of the House Ways & Means Committee.
Here’s another version of that matrix, this time including the Rubio-Lee plan.
As you can see, the Rubio-Lee plan gets top scores for “saving and investment” and “international competitiveness.”
And since these components have big implications for growth, the proposal would – if enacted – generate big benefits. The economy would grow faster, more jobs would be created, workers would enjoy higher wages, and American companies would be far more competitive.
By the way, if there was (and there probably should be) a “tax burden” grade in my matrix, the Rubio-Lee plan almost surely would get an “A+” score because the overall proposal is a substantial tax cut based on static scoring.
And even with dynamic scoring, this plan will reduce the amount of money going to Washington in the near future.
Of course, faster future growth will lead to more taxable income, so there will be revenue feedback. So the size of the tax cut will shrink over time, but even a curmudgeon like me doesn’t get that upset if politicians get more revenue because more Americans are working and earning higher wages.
That simply means another opportunity to push for more tax relief!
What’s missing in Rubio-Lee
There are a few features of the tax code that aren’t addressed in the plan.
The health care exclusion is left untouched, largely because the two lawmakers understand that phasing out that preference is best handled as part of a combined tax reform/health reform proposal.
Some itemized deductions are left untouched, or simply tweaked.
And I’m not aware of any changes that would strengthen the legal rights of taxpayers when dealing with the IRS.
Let’s close with a reminder of what very good tax policy looks like.
To their credit, Rubio and Lee would move the tax code in the direction of a flat tax, though sometimes in a haphazard fashion.
P.S. There is a big debate on the degree to which the tax code should provide large child credits. As I wrote in the Wall Street Journal last year, I much prefer lower tax rates since faster growth is the most effective long-run way to bolster the economic status of families.
But even the flat tax has a generous family-based allowance, so it’s largely a political judgement on how much tax relief should be dedicated to kids and how much should be used to lower tax rates.
That being said, I think the so-called reform conservatives undermine their case when they argue child-oriented tax relief is good because it might subsidize the creation of future taxpayers to prop up entitlement programs. We need to reform those programs, not give them more money.
[…] better than the current system, have features that I find troublesome. Marco Rubio, for instance, leaves the top tax rate at 35 percent, seven-percentage points higher than when Ronald Reagan left […]
I think for individual filers and joint filers, their tax rate should be the same. That and elimination of the death tax, alternative minimum tax, payroll tax and the capital gains tax.
[…] better than the current system, have features that I find troublesome. Marco Rubio, for instance, leaves the top tax rate at 35 percent, seven-percentage points higher than when Ronald Reagan left […]
[…] better than the current system, have features that I find troublesome. Marco Rubio, for instance,leaves the top tax rate at 35 percent, seven-percentage points higher than when Ronald Reagan left […]
[…] better than the current system, have features that I find troublesome. Marco Rubio, for instance, leaves the top tax rate at 35 percent, seven-percentage points higher than when Ronald Reagan left […]
[…] better than the current system, have features that I find troublesome. Marco Rubio, for instance, leaves the top tax rate at 35 percent, seven-percentage points higher than when Ronald Reagan left […]
[…] Marco Rubio is right to criticize plans that include a VAT, but that doesn’t mean his plan is free of warts. For what it’s worth, the candidate with the best plan is Ben Carson. Not […]
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[…] Jindal and Donald Trump have large tax cuts, and Jeb Bush, Rand Paul, and Marco Rubio are proposing smaller – but still significant – reductions in the federal tax […]
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[…] are talking about partial tax reform and I’ve specifically analyzed the plans put forth by Marco Rubio, Rand Paul, Jeb Bush, and Donald […]
[…] are talking about partial tax reform and I’ve specifically analyzed the plans put forth by Marco Rubio, Rand Paul, Jeb Bush, and Donald […]
[…] Here’s what I wrote about the plans put forth by Marco Rubio and Rand […]
[…] on these criteria, I’ve already reviewed the tax reform plan put forth by Marco Rubio. And I’ve analyzed the proposal introduced by Rand […]
[…] on these criteria, I’ve already reviewed the tax reform plan put forth by Marco Rubio. And I’ve analyzed the proposal introduced by Rand […]
[…] I see the “reform conservatives” as allies even if their ideal version of tax reform has a few […]
[…] I see the “reform conservatives” as allies even if their ideal version of tax reform has a few […]
[…] few months ago, I wrote about a sweeping proposal by Senator Marco Rubio of […]
[…] few months ago, I wrote about a sweeping proposal by Senator Marco Rubio of […]
[…] few months ago, I wrote about a sweeping proposal by Senator Marco Rubio of […]
[…] a short video of Dan Mitchell explaining the Flat Tax. Some of it is compelling stuff. But the 17 percent rate […]
[…] now, but it wouldn’t be as good as it could be. Indeed, the plan is conceptually similar to the Rubio-Lee proposal, but with a lot more […]
dickface
I think we can all agree that the private economy would boom with low taxes. However government does provide essential services, so the question is what form of tax is best for all. Consumption taxes directly impact prices for all. Taxes on wealth may seem to hit those who elect not to consume now and accumulate wealth. Rather the burden falls on things not done. Jobs require revenues OR investment capital to pay salaries. New jobs require investment until revenue streams can provide adequate support. Capital assets require up front investment until paid back through future revenues. The improvement in productivity translates to higher salaries for some and lower prices for all.
Taxes on wealth have a huge impact on the actions of wealth owners. Because of that the question to be asked is not how much can be raised through a tax on wealth but rather what will the future economy look like as a result of such taxes or conversely what would it look like in the absence.
While we cannot know the future, we can look at what has happened in the past. I’m now in Slovacia where they are recovering from a long period without private investment and innovation. Without private capital, they are desperate to bring foreign capital here. Do you think it wise for the U.S. to make such investments relatively more attractive?
Henry V
Sorry, I missed your earlier comment, been traveling.
Corporations collect taxes through salary tax withholding and they then pay taxes on corporate profits along with mandated employment fees and taxes but as you mentioned they are only the conduit for taxes ultimately paid by the consumer, as part of the final cost of the product or service. While the last corporation in a supply chain collects only the taxes that relate to their portion of the production/sales process the final price includes all taxes collected.
The only way to reduce prices is to reduce tax revenues collected. Lowering the tax rates by eliminating deductions will not help. Eliminating corporate taxes will affect prices only if other taxes are not raised to compensate.
If tax revenues are lowered per unit sold and it is reflected in a lower price, the number of units sold should go up. It will not make up all of the revenue lost, because that would indicate that the initial price had been set too high by the corporation.
Theoretically the best tax should be based on price. However, in practice, eliminating the taxes on salaries is the equivalent of giving everyone a raise, which must be included in the final price. Also, such a tax would disadvantage privately supplied services verses those untaxed services supplied by government.
[…] all double taxation and keep rates about where they are now, you get the Rubio-Lee tax plan, which I’ve also argued is a positive […]
Funny how, when y’all bitch about “Double Taxation”, you never suggest eliminating wage taxes to solve that problem. It’s always used as an excuse to lower taxes on the income streams for the wealthiest people.
[…] that people want bold reform, which is a proxy for ending tax-code corruption. I’ve already praised the Lee-Rubio plan, which Ramesh likes, but I have a hard time imagining that such a plan will seize the public […]
[…] that people want bold reform, which is a proxy for ending tax-code corruption. I’ve already praised the Lee-Rubio plan, which Ramesh likes, but I have a hard time imagining that such a plan will seize the public […]
[…] vil alltid være et stridsspørsmål, mellom høyre- og venstresiden, og blant økonomer. Her er en kritisk analyse av skatteplanen fra libertarianske Cato Institute, som mener at Rubio ikke går langt […]
[…] suggest that Rubio-Lee is bad tax policy. It’s a huge improvement over the current system. As I wrote last month, it’s a very good tax reform plan. It is especially good about fixing some of the worst […]
[…] some GOP Senators want to modify the current system to get rid of most double […]
[…] some GOP Senators want to modify the current system to get rid of most double […]
Dan, here’s the link to the full article excerpted above. I also borrowed your gradebook. Nice work! http://gonzoecon.com/2015/03/tax-policy-and-economic-growth/
[…] Today’s Wall Street Journal has two op-ed pieces on U.S. tax policy and economic growth. The first, and most detailed, is a proposal by Senators Marco Rubio and Mike Lee. The second, more general, is by Stanford Prof. John B. Taylor. Both advocate lower tax rates and a flatter tax system while broadening the tax base. There’s a good discussion of the Rubio-Lee proposal by Dan Mitchell at the International Liberty blog. […]
Dan:
If you were to include my 10-25 Plan in your tax plan comparison, you would find it receives all “A’s”. The only quibble might be the “Social Engineering” grade, since it does include a hefty prebate, which does go to every citizen.
However, no plan can be politically successful if it does not include some progressivity or safety-net.
While I agree a combined tax reform/health reform would be better, we must also include welfare reform. The loss of benefits from earning income creates a compounded tax rate.
Hayek stated in “The Road to Serfdom” “adequate security against severe privation, and the avoidable cause of misdirected effort and consequent disappointment, will have to be one of the main goals of policy. But if these endeavors are to be successful and are not to destroy individual freedom, security must be provided outside the market and competition left to function unobstructed.”
While the FairTax has its problems, a “prebate” operates outside the market, in that it is unaffected by the amount of income earned. A portion of the prebate could be deposited into a Health Savings Account, to replace all healthcare tax deductions, all Obamacare subsidies, some Medicaid and some Medicare for no net cost. Then we could let the free market operate in healthcare, while removing disincentives.
nedlandp,
I don’t disagree with your comments, but still wonder just why we tax corporations at all. They simply pass tax costs along to all of us in the form of higher prices. The major problem I see if we eliminate all corporate taxes is finding a way to ensure that prices really do go down accordingly. Only competition can do that trick, and competition isn’t equal throughout the nation. Your thoughts?
My comment to Henry points out the flaw in lowering the corporate rate. If you reduce the corporate rate, in order to collect the same amount of taxes, you must raise the rate on earned income.
It is true that a lower corporate rate may reduce the tax avoidance games by the more sophisticated corporate players, but that is balanced by the tax avoidance increase from individuals who can shift personal income to corporate income status.
Henry:
There is no difference to the consumer, if taxes are collected on income or on sales. It is the consumer who ultimately pays both taxes, since taxes in either form raise prices.
For example, if the price is 100 of which 25 relates to taxes on income and the price is 100 of which 25 relates to sale price; the consumer is unaffected by the change.
Arguments about which tax is better assume that the same amount of taxes will be collected.
[…] Reposted from International Liberty. […]
Suggest to Rubio and Lee to check Forbes idea. Much fairer.
Sent from my iPad
[…] P.S. There WAIT, THERE’S MORE… […]
Dan,
I’m baffled as to why you give the sales tax an “A” for fairness. Are you aware that seniors get thrown under the bus by (1) double taxing their after tax savings on which many depend; (2) forcing current retirees to resume paying for their SS benefits with their sales tax dollars; and (3) all middle class retirees will have a higher federal tax burden than under current law.
Is any of that fair to us old folks?
[…] By Dan Mitchell […]