House Ways and Means Committee Chairman Dave Camp (R.-Mich.) has released his comprehensive tax reform plan. The good news is that his package is not a net tax increase, but, rather, a modest net tax cut coupled with a modest spending reduction as well. That is a big deal in attaining a major pro-growth tax reform package.
President Obama and Congressional Democrats have said for years that they won???t even talk about tax reform unless they are able to extract a ransom in the form of a net tax increase of at least $1 trillion over a decade. The Camp draft wisely avoids taking this bait.
For most Americans, the Camp draft would represent a decided consumer experience improvement over today???s dreary tax season. The percentage of Americans who claim the standard deduction (and are thereby freed from keeping most tax records) would increase from 70 to 95 percent of all families. Ninety-nine percent of Americans would live with a simple, two-bracket tax system with a top rate of 25 percent. The dreaded ???Alternative Minimum Tax??? (AMT) is repealed. The corporate income tax rate (highest in the developed world) is reduced from 35 to 25 percent, closer to the rates imposed by our biggest trading partners. Much of the current system???s double taxation of international income is repealed.
Even better, the Camp draft compelled Congress??? Joint Tax Committee (JCT) to produce its first-ever dynamic analysis. Usually, JCT pretends that changes to tax law don???t have any larger effects on the economy. This time, they actually modeled for the changes. What they found is that the economy would grow faster, more Americans would be working (especially in the private sector), and we???d all be better off. In turn, this will throw off additional tax revenue derived entirely from economic growth???up to nearly $700 billion in the first decade alone.
All that said, the Camp draft has some big downsides.
For one thing, it chooses not to use any of the ???dynamic score??? revenue windfall for further tax relief, which results in some painful tradeoffs I???ll detail below. Additionally, the Camp draft uses a definition of ???revenue neutral??? which assumes that Congress will permanently let expire the 55 ???tax extenders??? which Congress has never let expire for good. Assuming instead that Congress would do what it always has done would have lowered the Camp draft???s revenue target by an additional $1 trillion over the ten-year budget window.
The resulting tradeoffs are costly. In order to get back to revenue neutrality, the Camp plan imposes a higher tax rate (35 percent) on partnerships, Subchapter-S corporations, sole proprietorships, and LLCs (collectively known as ???flow-throughs???) than it does on the biggest corporations (25 percent). This is despite the fact that ALL forms of business lose business tax deductions equally. The tax code should not pick winners and losers, especially if the losers tend to be successful startup firms.
The Camp draft dramatically raises taxes on capital. The capital gains and dividends marginal rate is actually raised slightly from today???s levels (23.8 percent up to 24.8 percent). Even worse, the number of years businesses must stretch out tax deductions for asset purchases (a process known as ???depreciation???) is extended and slowed down. This moves in the opposite direction of where it should. Ideally, all business inputs would be deducted from taxable income in the year of purchase.
These tradeoffs result in some big negatives in the dynamic score. JCT says that annual business capital investment will fall (starting at just the moment when the slower business investment cost recovery tax regime is implemented). The Heritage Foundation confirmed this in their own macroeconomic analysis, which shows gross private domestic investment falling on the same schedule.
Over time, this is likely to result in far less economic growth derived from tax reform than one might expect. In fact, there???s a chance that the economic growth effect might be negative once the entire plan is phased in (though that???s not clear from the data we have). Capital is the seed corn of future economic growth. If you tax something higher, you get less of it over time.
Thankfully, the capital tax hole in the Camp plan is fairly easy to fix with a patch. All it requires is the will to use the $700 billion JCT has helpfully provided in the dynamic analysis??? revenue windfall, and the $1 trillion that a more realistic baseline frees up. ATR has estimated that this money is sufficient to do three essential things:
· Cut the capital gains and dividends tax rate to zero
· Enact full business expensing of business assets
· Cut the tax rate on flow-through businesses to 25 percent
Besides these policy solutions, the Camp draft needs a political regime willing to implement this plan. The GOP House of Representatives stands ready to pass a pro-growth, robust, and manly tax reform plan like the one described above. But so long as Senator Harry Reid (D-Nev.) runs the U.S. Senate and Democrats control the committees in the upper chamber, any good tax plan is dead on arrival. Fortunately, voters can take care of this part of the equation this November, when a net pickup of six seats will turn a Democrat Senate into a Republican one.
That???s to say nothing of the giant roadblock on the other end of Pennsylvania Avenue, President Barack Obama. He still will demand his $1 trillion tax hike ransom even if he loses the Senate. It will take a Republican president to sign anything like a Camp-plus-capital tax reform plan into law.
Dave Camp is to be commended for starting this conversation. It will be up to the American people to decide whether it ends with a Rose Garden signing ceremony or not.
Norquist is president of Americans for Tax Reform ??? follow him on Twitter at @GroverNorquist.