To Help Families, Don’t Cut Their Taxes

(Bloomberg View) -

The House Republicans’ tax proposal focuses mostly on increasing business investment. Many critics of the bill think it should lean more heavily towards providing immediate tax relief to American families. I’m not one of them.

Over the long term, individual income tax cuts wouldn’t do nearly as much for families as encouraging business investment, and the productivity and wage increases that come from it.

Other critics make a different argument: That the current economic climate renders the corporate tax cuts at the heart of the bill a poor way to stimulate business investment. Corporations are sitting on piles of cash, interest rates are low and the economy is close to full employment. In this environment, why should we expect a reduction in business taxes to increase investment enough to matter?

This criticism is off base, too. First, let’s not downplay the magnitude of the investment incentives in the House bill. Slashing the corporate rate nearly in half and allowing businesses to write off the cost of new investment might do a lot, even in today’s environment. More importantly, these changes are meant to stand in place for decades, helping to sustain a strong economy even if interest rates rise and employment falters.

The House bill also does a surprising amount to eliminate inefficient and unwise tax deductions. Significantly scaling back the mortgage-interest and business-interest deductions, and eliminating the deduction for state and local income tax and the preferential rate for manufacturing activities are a few examples of the hard choices made in crafting the bill.

Yes, some of these hard choices might result in tax increases for many middle-class households. This has been widely criticized, in part because of President Donald Trump’s exaggerated rhetoric about the benefits of tax reform for the middle class. But it’s better for the government to lose revenue by encouraging business investment than to subsidize members of the middle class who purchase large homes or who choose to live in high-tax states. Investment increases economic growth, the fruits of which we will all (eventually) share. The subsidies don’t.

So there is much to like in the House proposal. That said, the bill should be considered an opening bid — the first scene in a multi-act drama. As the legislative process unfolds, how should Congress improve the bill?

The most important shortcoming of the House bill is its impact on the national debt. The official estimate finds that the bill will increase the debt by around $1.4 trillion over 10 years. Adding in the cost of interest on the new debt and realistically assuming that some important temporary provisions in the bill — the ability immediately to write off new investment and tax credits for households — will be extended by future Congresses, the estimated total new debt rises above $2 trillion.

All the usual reasons to be concerned about so much new debt apply. Over time, the debt would slow economic growth and reduce wages, undoing the good done by encouraging investment in the first place. In addition, $2 trillion in additional debt makes it harder for the government to respond to a recession, and possibly even increases the likelihood of a fiscal crisis.

Big new debt obligations would also make it harder to finance programs that help fight poverty and advance opportunity. Take the earned-income tax credit, an earnings subsidy for low-income, working households that increases employment and lifts millions out of poverty each year. Both President Barack Obama and House Speaker Paul Ryan are on record supporting its expansion, with nearly identical proposals a few years ago. The cost: $60 billion over 10 years. That sounds like a lot, but compared to the $53 trillion the government will spend over the next 10 years, it isn’t.

So why can’t this get done? In large part, because of the bipartisan agreement in Washington that there should be a large entitlement state for the middle class, paid for by borrowing money. The more money we borrow, the harder it is politically to enact evidenced-based solutions to pressing policy problems, like expanding the earned-income tax credit. The House tax bill exacerbates this problem at a time when rapid economic, demographic and social change will increasingly require policy innovation.

To address this unfortunate feature, Congress should start by scaling back tax relief for the wealthy. The House bill leaves the top marginal individual income tax rate at 39.6 percent, but increases the threshold for that bracket from $470,000 to $1,000,000 (for joint returns). Keeping the threshold at the current lower level, along with foregoing estate-tax repeal, would reduce the cost of the bill by over $200 billion in the first 10 years, and by significantly more than that over the long term.

Second, Congress might rethink the large cut for partnerships, limited-liability companies and sole proprietorships. The proposed 25 percent tax rate on “pass-through” income from these entities, down from the top rate of 39.6 percent, costs around $450 billion. Enforcing this provision would be administratively complex, and its ability to increase business investment is questionable given other provisions in the bill that allow for investment expensing for small businesses. (Congress should make those provisions permanent, too.)

Finally, the bill should do more to fight poverty and advance opportunity. Expand the earned-income tax credit. Expand the separate tax credit for children in the low-income households that need assistance the most, not just for upper-income households. Consider adding targeted provisions to increase geographic mobility for the long-term unemployed.

These improvements aren’t comprehensive, but here’s the gist: Less tax relief for the wealthy. No increase in long-term debt. A focus on investment, growth, wages, and opportunity. The House bill is a start. But Congress, your work isn’t done.