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Taxes and the Budget at Year’s End

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The tax reform plan that Congress is producing will not be perfect. Nothing is. One would do well to remember that the choice Congress makes is never between perfect legislation and what it produces, but between what it produces and current law. With, at the time of this writing, a mere fifteen legislative days left this year, let’s take a look at the tax plan that appears to be developing and try to predict whether it improves on current law.

The starting point for any inquiry should be the purpose of the legislation and whether the developing product generally would move the law in the direction envisioned by the legislators. The stated purpose for this tax bill is to simplify the code for most individual taxpayers and reduce taxes for both individuals and businesses in order to spur economic growth. The theory, which has generally proven correct in the past, is that tax cuts lead to economic activities which cause job growth, improve wages, and make society more prosperous on the whole.

Congress has relegated to secondary and tertiary consideration whether the proposed tax plan would increase the annual deficit and the national debt over time and whether the bill represents good tax policy. Good tax policy for the purposes for this analysis is defined as whether the tax law raises or lowers revenue for the government without picking winners and losers and focuses exclusively on raising the amount of revenue necessary to pay for all that government does.

Given that the government is already borrowing vast amounts of money to pay for current expenditures, a tax cut of more than $1 trillion certainly could increase the annual federal budget deficit by some amount because even the Laffer Curve, named for famed economist Arthur Laffer who advised President Reagan, does not show that tax cuts pay for themselves beyond a certain point. However, there is a great deal of dispute about where the optimum point of tax cuts lie. The tax bill under consideration also would allow for the return of more than $2 trillion in corporate profits currently setting off-shore and beyond the reach of the federal tax man. Bringing that $2 trillion back into the United States would be a massive stimulus to the economy which currently produces about $17 trillion annually and this adds to the uncertainty about the point beyond which tax cuts would not pay for themselves.

The plans being proposed are a mixed bag of good and bad tax policy using the definition above. Removing or reducing the Home Mortgage Interest deduction and the deduction for state and local taxes is good policy because it stops the picking of winners and losers in the code. Studies indicate that the home mortgage interest deduction does not actually encourage home ownership but probably causes people to buy larger homes than they otherwise would. We should also ask why the tax code favors a home purchaser in Iowa over an apartment dweller in New York. Likewise, the tax code should not favor taxpayers in high-tax Connecticut or California over low-tax Tennessee or Texas through the State and Local Tax Deduction.

Expansion or even continuation of the Child Tax Credit and Earned Income Tax Credit (EITC) are poor tax policies because those provisions are designed to reward certain behaviors at the expense of others and do not lead to much economic growth while causing the government to forego a great deal of revenue. While the EITC may have admirable ends, the same goals could be accomplished more efficiently through the welfare payment system.

With those caveats in mind, the plans under consideration in Congress appear to achieve at least some, if not most, of the stated aims for the legislation. Doubling the personal exemption will mean most taxpayers will be able to file their taxes on a one-page form. The changes to the expensing provisions means that small businesses will be able to write off investments in new plant and equipment in the year in which the expense occurs rather than depreciating it over a number of years. That is both a simplification and reduction in one-fell-swoop, which should allow small businesses to have more money to expand, innovate, and spur the economy.

Reducing the corporate tax rate should help to make American companies more competitive with their overseas rivals and peers. The cut in the corporate rate, by most analyses, should be a major stimulus to job creation and economic growth. Stock markets have already grown substantially in the simple anticipation of the cuts. Allowing $2 trillion in corporate profits to come back into the United States will provide a stimulus to the economy which will obviously have some impact on growth and likely a moderate to large amount of growth will result from it.

Most taxpayers will see more money in their pockets as a result of the plans being considered. Best estimates indicate a so-called average family of four would see an additional $1,200 in the family’s coffers once the legislation is enacted. For Virginia, the Tax Foundation estimates that a middle income family will see an after tax income gain of $2,924. The Tax Foundation also estimates that Virginia would see job growth of more than 25,000 full-time equivalent positions as a result of the tax law changes.

There are likely to be some higher income earners whose particular circumstances result in little or no tax reduction but they should be the exception rather than the rule under the terms of the current proposals. Nonetheless, every state would see job growth and the vast majority of taxpayers should benefit from the proposed plans.

Claims that the current tax proposals will amount to a massive budget buster may or may not be correct. The best estimates by the Joint Committee on Taxation, the congressional scorekeeper for the results of changes in the tax laws, indicate the proposed tax cuts will contribute substantially to the debt but their models do not account for the growth that will almost surely follow such a massive tax cut. While the Joint Committee on Taxation does as well as any group in making these predictions, their track record for failed predictions would send a race horse out to pasture. In truth we are in unknown territory as to how much, if any, increase in the debt will result from the proposed changes in the tax law.

Given the anemic growth of the economy and long stagnant wages, this plan may be just the shot in the arm the economy needs to increase our prosperity. It would be even better if it were accompanied by spending restraints and reforms of our precariously funded entitlement programs but the perfect must not be the enemy of the good. The proposed tax legislation will result in growth and that is worth the risk.

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