Ryan's Sweeping Tax Reform and the Left's Inane Response

Paul Ryan and the House Republicans' 2012 budget cuts 5.8 trillion in government spending over the next decade and reduces the federal debt by 4.4 trillion relative to the CBO baseline.  Tax reform is a key element of the Ryan proposal that has already come under attack from the left.  Democrats falsely believe that a return to Clinton era taxes, especially on "the rich," is a prerequisite for increasing revenue and bringing down the debt over the coming years.  While a "tax the rich more" approach is a useful demagogic tool, the relationship between tax rates and tax revenue is not as simple as it may seem.  Furthermore, corruption, inefficiencies, and inequities would likely increase under a strategy that simply raises taxes on the backbone of the existing system.

America's tax code is already needlessly complex, full of loopholes for those wealthy enough to take advantage, and wrought with individual and corporate subsidies.  It discourages work, saving, and investment through high individual rates and duplicative taxation policies such as the death tax and capital gains tax.  The United States assumes the throne of the highest corporate income tax in the industrialized world this month, severely limiting the ability of businesses to invest in expansion and hiring.  However, corporate welfare queens like GE who lawfully game the system via cronyism and lobbying efforts can end up paying no money in taxes, as was the case this tax season. [i-iii]

In their report titled The Moment of Truth the bipartisan fiscal commission states:

America's tax code is broken and must be reformed...Instead of promoting economic growth and competitiveness, our current code drives up health care costs and provides special treatment to special interests. The code presents individuals and businesses with perverse economic incentives instead of a level playing field.

In short, the Commission has concluded what most taxpayers already know - the current income tax is fundamentally unfair, far too complex, and long overdue for sweeping reform.

Tax reform should lower tax rates, reduce the deficit, simplify the tax code, reduce the tax gap, and make America the best place to start a business and create jobs.

Ryan's plan simplifies the tax code, broadly lowers rates, and eliminates most of the existing subsidies and exclusions.  In the words of Indiana Governor Mitch Daniels, it moves the tax code in the direction of something that "looks like it was designed on purpose."  The purpose, as Daniels points out, "being economic growth."  Ryan's plan lowers tax rates to 10% on income up to $100,000 for joint filers, and $50,000 for single filers; and 25% on taxable income above these amounts.  It includes a generous standard deduction and personal exemption (totaling $39,000 for a family of four); otherwise, it eliminates all special deductions, credits, or exclusions except the healthcare tax credit.  The plan promotes saving and investment by eliminating taxes on interest, capital gains, and dividends and it eliminates the death tax.  Finally, it replaces the corporate income tax with a border-adjustable business consumption tax of 8.5%.  This new rate, according to Ryan, is roughly half that of the rest of the industrialized world.

Progressive critics are already screaming that it sacrifices the poor and middle-class to spare the rich.  Furthermore, they claim it will result in lost revenue to the Treasury, thus necessitating even more painful cuts to government programs that overwhelmingly benefit the groups they claim to champion.

But is it true that cutting tax rates automatically reduces tax revenue?  To those incapable of understanding complex systems and to those looking for straw men, the answer is "yes."  Take for example the progressive group Citizens for Tax Justice (CTJ).  In their analysis of the Ryan plan, they claim that if his proposal were enacted in 2011, the federal government would receive $182 billion less in revenue compared to Obama's plan, which would let the Bush tax cuts expire on those making more than 250K/year.  It would be bad enough if their analysis ended with 2011, but to produce a more shocking number they extrapolate over the next decade.  The conclusion of their analysis: compared to Obama's plan, Ryan's would cost the federal government $2 trillion in lost revenue.  Wow!

The CTJ analysis is a great example of the phrase, "garbage in, garbage out"; because it uses static revenue analysis it is an invalid model.  On a macroeconomic level, static revenue analysis assumes that projections of economic growth will not change under varying levels of taxation.  On an individual level this means a person who earns and reports 250K at a tax rate of 20% will do the same at a rate of 25%, 35%, 45%, etc.  Does this seem reasonable to you?  What if the tax rate were 100%?

High tax rates discourage work effort, saving, investment, business expansion, and hiring and promote tax avoidance and tax evasion.  The Laffer curve (Figure 1) merely formalizes the common sense observations that:

1. Tax revenues depend on the tax base as well as the tax rate,

2. Raising tax rates discourages the taxed behavior and therefore shrinks the tax base, offsetting some or all of the revenue gains, and

3. Lowering tax rates encourages the taxed behavior and expands the tax base, offsetting some or all of the revenue loss.

                              Figure 1: The Laffer curve

In 1980, individual income tax revenue was $244 billion and the American economy was in recession.  With the Economic Recovery Tax Act (ERTA) of 1981 President Reagan reduced rates by 25% across the board and cut them again in 1986.  The result, individual income tax revenue in 1989 was $446 billion -- a near doubling of revenue.  Margaret Thatcher provided a cogent analysis on the dynamic effects of Reagan's tax reforms:

When barriers to enterprise are removed and taxes cut to sensible levels, people have the incentive to work harder and earn more. They thereby benefit themselves, their families, and the whole community. Hence the buoyant economy of the Reagan years. It expanded by a full 25 percent over 72 months of continuous economic growth -- the longest period of peacetime economic growth in U.S. history; it spread prosperity widely; and cut unemployment to the lowest level in over a decade.

The Reagan tax cuts showed that reducing excessive tax rates stimulates growth, reduces tax avoidance, and can increase the amount and share of tax payments generated.  There is little reason to expect the left's static revenue analysis to evaluate the economic or distributional effects of Ryan's tax reform proposal much better than it evaluated Reagan's 30 years ago.

Ryan's ambitious plan to reduce the size of government and fundamentally reform the tax code presents us with an opportunity to recapture the early American ideals of self-reliance, freedom from excessive taxation, and boundless enterprise.  It would unleash a torrent of economic activity to create wealth (yes, it is created not distributed), open doors of opportunity, and increase the standard of living for all Americans.

Andrew Foy, MD and Brenton Stransky are authors of The Young Conservative's Field Guide and proprietors of the popular I-Phone application Conservative Quote of the Day.  Andrew can be contacted at Andrew.Foy@gmail.com.

[i] GE's CEO Jeffrey Immelt was recently appointed to chair the President's Council on Jobs and Competitiveness.

[ii] GE was the largest corporate donor to President Obama's 2008 campaign.

[iii] GE is an equal opportunity lobbyer as they contributed extensively to President Bush as well as those who went before him.