Middle-Class Tax Cuts, Deficits, and the Business Cycle

D.C. is all abuzz about tax reform, the first such legislation since 1986. Republicans want to reform the federal income tax, both personal (i.e. individual) and corporate. After failing to pass a repeal of ObamaCare, some think that tax reform is a must if the GOP wants to retain its majorities in Congress.

Republicans have been selling their tax reform by stressing income tax rate cuts for the middle class. But the middle class already pays at a very low rate. For example, the Middle Quintile paid at an average income tax rate of just 2.6 percent in 2013. To verify that go to page 10 (pdf-14) of this June 2016 CBO report and read the first paragraph in the right column; then go to Figure 5 on page 12 and read the footnotes for methodology.

Personal income taxes are already highly progressive, and have been for decades (see this chart). Republicans should not be in the business of making them even more so by exempting yet more income earners from paying income taxes. For years now, the top 5 percent has accounted for more than half of personal income tax revenue while the bottom two quintiles have had a negative effective income tax rate. With their talk of cutting tax rates for the middle class, one wonders if Republicans want to expand the number of Americans who file income tax returns just to get government handouts, like the EITC.

Real tax reform can’t just be about cutting rates, it must also be about going after the Tax Code. That mainly means cutting exceptions to paying one’s taxes; i.e. exemptions, deductions, loopholes, etc. Everyone agrees that the Code is a mess and needs to be radically simplified, but nobody wants to give up the exceptions they benefit from, like the deduction for SALT: state and local taxes.

On Oct. 31, The Hill ran “We must get SALT out of taxpayers' diets,” a terrific article by Sal Nuzzo and Jonathan Williams who write that SALT is “worth an estimated $1.3 trillion over the next decade” which could be “used to reduce tax rates for all individuals and business.” With the SALT deduction, efficient low-tax states are effectively subsidizing inefficient high-tax states.

When many middle-class taxpayers have an effective rate that’s about a tenth of their marginal rate (i.e. the statutory rate on their last dollar), then why is it so necessary to give them a rate cut? The way to justify rate cuts is to pair them with offsetting cuts in exceptions.

With very vocal constituencies for every exception in the Code, especially deductions for SALT, mortgages, charity, tax-deferred retirement plans, and such, it may be difficult to get 50 senators to sign on for reforming the personal income tax. But the personal income tax isn’t the more important tax to reform. On Oct. 2, the Weekly Standard ran “It's the Corporate Tax Rate, Stupid” by Tony Mecia:

If you talk to economists, though, what’s clear is that of all the possible tax-policy choices facing lawmakers, the one with the biggest potential economic pop is cutting tax rates on business income.

“If the goal is to increase economic growth -- and I think I’m in a group of a majority of economists -- then changing the corporate tax rate would be the most beneficial,” says Michael Walden, an economist at North Carolina State University. “If you look at the studies, and there have certainly been scores of them over decades about what elements of the tax code increase economic growth the most, it’s the corporate tax rate.”

The federal government taxes corporations at a rate of 35 percent of their income. Add an average of 5 percent for state taxes, and the typical U.S. corporation pays 40 percent in taxes. Because of loopholes and deductions, the actual percentage is often less, of course, but the statutory figure is more than any other country except the United Arab Emirates, according to a survey by tax consultancy KPMG. The Scandinavian nations, long considered models of humane socialism, have corporate tax rates that average 22 percent.

The economic rationale for lowering the corporate tax rate is straightforward: Cut taxes and companies have more money to pay workers, return to shareholders, and invest -- all of which have rapid economic benefits.

Getting American corporations into a more globally competitive position should be the #1 priority of current tax reform legislation, not cutting rates for the middle class. That means not only cutting corporate rates, but also cutting their costs of compliance. President Trump has already done much to ease regulations, now Congress should do the same by ridding the Tax Code of costly red tape. We can unshackle America business by simplifying the Code.

On Nov. 1, Cato Institute ran “Aren’t Republicans Supposed to Care about the Deficit?” by Michael Tanner. The deficit is one of my big concerns, but in D.C. it never seems to be the right time to cut it, much less balance the budget. Tanner cites the CBO’s projection that “we will return to the era of trillion-dollar deficits as soon as 2022.” On Sept. 30, Congress finished out a fiscal year during which they ran a $666B deficit, and now they’re going to accept lower revenue for the sake of income tax rate cuts for a middle class that already pays very little?

I’m probably one of the few conservatives who think that taxes could be raised on the middle class by a skotsch, maybe a percent or so. That may make me an apostate. But what I’m really for is spending cuts, which Republicans aren’t much better at than Democrats. The GOP tax package is said to lower revenue by some $1.5T over ten years. How about some spending cuts before tax rate cuts?

Having started in the middle of 2009, the current economic expansion is fairly long in the tooth, and tax rate cuts are not going to repeal the “business cycle.” Does Congress think it can outlaw recessions? If a recession were to hit the same time as cuts in revenue, the deficit would explode. Economist Scott Sumner writes: “In the previous few recessions, the consensus of economists did not even forecast a recession until it was already underway. That is, not only can economists not forecast the economy, they can't even ‘nowcast’ the economy.”

It should be noted that Congress recently failed at passing a serious tax cut: the repeal of ObamaCare. A repeal of the ACA mandates alone would be a significant tax cut for both individuals and businesses. And then there are the other taxes in ObamaCare. If Republicans hit some snags on tax reform, they should immediately pivot and repeal the ACA… in its entirety. Actually, they should do that anyway, and before January. And they should “sell” the repeal of the ACA as a huge tax cut, which it would be.

In this session of Congress, we’re not going to get a fundamental change in income taxes that might establish a new relationship between the federal government and the taxpayer. What we’re getting is tweaking around the edges. But that might be all that’s possible at this time. Those of us who want real change will have to wait.

Jon N. Hall of Ultracon Opinion is a programmer/analyst from Kansas City. 

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