Tax re­form com­pli­ca­tions

Tax cuts pay for them­selves, but it takes time

The Washington Times Daily - - OPINION - By Richard W. Rahn Richard W. Rahn is chair­man of Im­prob­a­ble Suc­cess Pro­duc­tions and on the board of the Amer­i­can Coun­cil for Cap­i­tal For­ma­tion.

Do you want tax re­form? Now, for the dif­fi­cult ques­tions: What is your def­i­ni­tion of tax re­form? And what will be the con­se­quences of each of your pro­pos­als?

Nearly all se­ri­ous tax re­form ad­vo­cates call for a re­duc­tion in the cor­po­rate in­come tax rate for sev­eral very sim­ple rea­sons: The United States has the high­est cor­po­rate tax rate in the world among ma­jor economies, which drives U.S. com­pa­nies to move to sun­nier tax climes and dis­cour­ages for­eign com­pa­nies from mov­ing to the U.S. — all of which re­duces the num­ber of jobs and eco­nomic growth. The cor­po­rate tax is cor­rectly re­garded by most tax pro­fes­sion­als as a ter­ri­ble tax for more rea­sons than can be de­scribed in this space. Re­cent stud­ies show that most of the cost of the tax falls on work­ers in terms of lower wages and ben­e­fits.

One im­ped­i­ment to con­struc­tive tax re­form is the very rules un­der which Congress op­er­ates. With­out get­ting into the com­plex­i­ties of the so-called bud­get “rec­on­cil­i­a­tion” process, tax re­form is lim­ited by a re­quire­ment that tax re­duc­tions be “paid for” by other tax in­creases or spend­ing cuts. For decades, many of us have been in the bat­tle to use “dy­namic scor­ing” rather than “static scor­ing” in de­ter­min­ing the “costs” of tax re­duc­tion. Dy­namic scor­ing is the at­tempt to look at the feed­back ef­fects of tax changes, such as the num­ber of new jobs and, hence, tax­able wages that would be cre­ated.

Did the Rea­gan tax rate cuts pay for them­selves in terms of new tax rev­enue that was cre­ated as a re­sult of the ad­di­tional eco­nomic growth gen­er­ated by the tax changes? Most tax econ­o­mists on the left have ar­gued “no,” and even many Repub­li­cans and free-mar­ket econ­o­mists have also ar­gued “no.” In an at­tempt to an­swer this ques­tion a num­ber of years ago, I looked at the pro­jec­tions made by the Con­gres­sional Bud­get Of­fice and the Carter ad­min­is­tra­tion of­fi­cials be­fore they left in 1981 — which fore­cast much lower lev­els of real eco­nomic growth than ac­tu­ally oc­curred af­ter the Rea­gan tax rate re­duc­tions. The eco­nomic pie grew more rapidly, but the per­cent go­ing to fed­eral in­come taxes de­clined. It took about seven years for the in­fla­tion-ad­justed eco­nomic pie to be­come suf­fi­ciently larger than the fore­casts made in 1980-81 to com­pen­sate for the tax rate re­duc­tions.

The rea­son the above his­tory is im­por­tant is that the ini­tial House of Rep­re­sen­ta­tives tax pro­posal con­tains a pro­vi­sion for a “border-ad­justable” cor­po­rate tax sys­tem (as a par­tial pay for the cor­po­rate rate re­duc­tions). In essence, the pro­posal would elim­i­nate much of the cor­po­rate in­come tax for prod­ucts that are ex­ported from the United States while not al­low­ing any cor­po­rate tax de­duc­tion for the cost of im­ported goods and ser­vices. In short, this means that im­ports would be taxed more heav­ily than U.S. ex­ports. A ma­jor prob­lem with the pro­posal is that many com­pa­nies that pro­duce and sell (and thus cre­ate jobs) in the United States rely heav­ily on im­ported raw ma­te­ri­als and com­po­nents, and such a tax pro­vi­sion could cost them dearly, forc­ing them to raise prices to Amer­i­can con­sumers and re­duce their U.S. work forces. The tax, as now pro­posed, would prob­a­bly be chal­lenged by the World Trade Or­ga­ni­za­tion as an un­fair sub­sidy, which might push the tax writers into mak­ing it a Value Added Tax (VAT) like the Euro­peans have, and which is border ad­justable ac­cord­ing to the rules. A VAT would be a whole new ma­jor tax, whose rates are eas­ily raised, as the Euro­peans have shown, lead­ing to big­ger gov­ern­ment and more eco­nomic stag­na­tion.

Some tax rate re­duc­tions, like the cap­i­tal gains tax, have al­most im­me­di­ate pos­i­tive eco­nomic feed­backs and of­ten pay for them­selves in as lit­tle as two or three years. Other in­come tax rate re­duc­tions take many years (as the Rea­gan re­duc­tions showed) to to­tally pay for them­selves, even as there were tremen­dous shorter term ben­e­fits in all of the new and higher-pay­ing jobs that were cre­ated.

It is im­por­tant that the tax writers in Congress not let them­selves be lim­ited by the Con­gres­sional Bud­get Of­fice and other tax mod­els that do largely static or very lim­ited dy­namic tax rev­enue fore­casts. They also need to have suf­fi­cient time hori­zons in their fore­cast mod­els to al­low the full ef­fect of the tax rate re­duc­tions to work through the econ­omy. For such pur­poses, a 10-year fore­cast may well be ap­pro­pri­ate.

Yes, cut­ting tax rates sharply will add to the deficit in the short run. But if prop­erly struc­tured, it should cre­ate many more jobs and even greater to­tal tax rev­enues in the long run. This will lead to a smaller fed­eral debt bur­den as a share of gross do­mes­tic prod­uct, if cou­pled with real spend­ing re­straint. At the same time, tax­ing im­ports will only drive up con­sumer prices, in­crease costs, and kill jobs for the mil­lions of Amer­i­can busi­nesses, which de­pend on for­eign com­po­nents and raw ma­te­ri­als to run their own busi­nesses.

Fi­nally, the fed­eral bud­get is so bloated, in­clud­ing mas­sive waste in the De­fense Depart­ment as was re­vealed this past week, that an al­most un­lim­ited num­ber of spend­ing re­duc­tion “pay fors” are avail­able if the new Trump ad­min­is­tra­tion and Congress are se­ri­ous about bud­get and tax re­form.

IL­LUS­TRA­TION BY GREG GROESCH

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