The tax bill, for all the partisan positioning around it as well as its real faults, takes a welcome step in the right direction. It makes a highly inequitable, anti-growth, and generally dis-functional tax code less so.
The bill, to its credit, draws on a long bipartisan reform legacy. It, much like the Reagan legislation of the mid-1980s, has eliminated tax breaks and used the resulting revenue flow to reduce statutory rates. These same principles informed the recommendations of President Obama’s 2010 National Committee on Fiscal Responsibility. Colloquially called Simpson-Bowles after its leadership, former Senator Alan Simpson and former White House Chief of Staff Erskine Bowles, it failed to become law, but Obama tried several times to press some of its measures on Congress. He actually proposed similar reforms in his 2015 budget. Republican reformers made similar basic recommendations. Proposals to eliminate or cap of tax breaks and pursue a cut in statutory rates appeared in the plan advanced in Obama’s first term by then chair of the House Ways and Means Committee, Republican David Camp. Republican Paul Ryan, when he took over the House Ways and Means Committee during Obama’s second term, embraced the same principles in a set of reforms that he referred to as a “better way.”
The same basic reasoning has stood behind all these reforms, including this latest legislation. All aimed at greater efficiency and more equity. A general reduction in statutory rates, it has been argued throughout, would enhance growth prospects by encouraging individuals to work and business to invest more for the future. Lower statutory corporate rates would further enhance growth prospects by encouraging greater efficiencies in business, inducing managers to think less about tax consequences and more about the economics of their respective businesses. 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.
There is care here to promote greater equity. No doubt Californians, New Yorkers, and other residents of high tax states see matters differently. This legislation limits deductions of state and local taxes of any kind to $10,000. But most of the county could argue a different line, and with justice. The old code, to make up for the revenues lost to those huge deductions, implicitly forced on all Americans higher statutory rates than they would otherwise have had to pay. People across the county effectively shouldered some of the burdens imposed by political decisions made in Sacramento, Albany, and a few other state capitals.
In addition to geographic equity, this new legislation takes clear steps toward securing equity across the income distribution. Previously, the law allowed people to deduct mortgage interest on loans all the way up to $1.0 million. Since the biggest mortgages garnered the greatest tax benefit, the wealthy gained the most from the provision. By lowering that cap to $750,000, the new law rectifies some but only some of the code’s pro-wealth bias. To even the relative tax burden across the income distribution further, this new legislation offers much to those at lower income levels. Because these taxpayers seldom itemize, it offers a near doubling in the standard deduction and major increases in child tax credits. Further, it raises the threshold of income before each taxpayer moves into a higher bracket and makes the biggest relative tax cuts in lower income brackets, those facing individuals who have taxable income below $200,000 a year and married couples with joint incomes below $400,000 a year.
Even the proposed elimination of the estate tax, though it seems to favor the very wealthy, can make an equity claim. The current code, though it seems to tax inheritance heavily, falls mostly on the middling rich, those who inherit family farms or small businesses. They frequently have to sell off their inheritance just to pay the tax. Meanwhile, the very rich, many of whom promote high estate taxes, protect their heirs by giving their money, tax free, to foundations where they see to it that those heirs have comfortable positions with sometimes lavish benefits. Whatever they may claim for the good their foundations do, they ensure that the benefits of their wealth pass from one generation to the next, tax free. The legislation simply allows the middling rich a break previously open only to the mega-rich.
The most questionable aspect of this new law is the provision that was the most contentious in the Senate: the break on unincorporated business earnings, the so-called pass through income. Those pressing for this argued that reductions in the corporate rate would bias the code against small business and limited liability partnerships that would have to pay at higher individual rates. Matters, however, are not that straightforward. Corporations pay their own tax and then shareholders pay at their individual rate, or close to it, when they receive any distributions, usually in the form of dividends. Combined then, the people behind the corporations indirectly and directly pay at about individual rate, just as those behind other business arrangements did. Giving a special break to these businesses now offers them an advantage. It is pleasant to think that a small business man or woman will find relief in this new law, but it raises questions why he or she should pay less tax than a corporate shareholder or the wage earner who lives next door.
Other aspects of this new law also fail to live up to the principles of efficiency and equity. They, as with this matter of pass-through income, no doubt reflect the kinds of compromises that typify any legislation. They detract from its appeal. But in considering any change in any law, the object is not to judge whether it is perfect or even consistent. No legislation could pass such a test. Rather the object is to consider whether the change improves on the existing legislation, whether it promotes more equity and greater economic efficiency. And on this test, the recent tax reform succeeds.