Santorum’s tax plan doesn’t add up
His plan would be both fiscally irresponsible and distortionary

Gage Skidmore

Article Highlights

  • Yes, Santorum's plan lowers taxes. The bad news? His tax relief is either welfare in disguise, or social engineering

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  • Rick Santorum's tax plan caters to the fetishistic political focus on giveaways to manufacturing

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  • Sad fact about Santorum's tax plan: No serious individual would spend any effort trying to get it through Congress

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Before the Iowa results rolled in, you could probably have counted on one hand the number of people who knew any of the details of Rick Santorum's economic plan.   But if the former senator is to repeat his success in Iowa, he will have to convince voters that his economic policies are serious, could plausibly become law, and will revive our flagging economy.   So far, each of the "Non-Romneys" has failed miserably at that task, unless, of course, you are someone who is comforted by the fantasy that the numbers will add up if we have 5 percent growth for a decade.  

Can Santorum pull it off?

The good news is that much of Santorum's plan is centered on lowering taxes.   The bad news is that much of his tax relief is either welfare in disguise, or social engineering.   After weighing the plusses and minuses, the conservative Tax Foundation gave his plan a D+.  That score might be generous.

His individual income tax plan has just two rates - 10 and 28 percent. He does not specify at what point those rates begin, but it is likely safe to assume that no one will experience a tax increase. His plan calls for the elimination of the AMT and the estate tax.

All that has much to recommend it, but Santorum would also triple the personal exemption for dependent children, while maintaining the earned income tax credit and the child tax credit.  This move would radically reduce the percentage of taxpayers paying any federal income tax whatsoever.  Since he would retain much of the other major individual tax deductions, complexity would not be reduced, but revenue would be radically lower.  I will return to this in a moment.

"Santorum would triple the personal exemption for dependent children, while maintaining the earned income tax credit and the child tax credit--this move would radically reduce the percentage of taxpayers paying any federal income tax whatsoever." - Kevin A. Hassett

His corporate plan would lower the top corporate tax rate from 35 to 17.5 percent, while eliminating the corporate income tax altogether for manufacturers; it would increase the Research and Development Tax Credit from 14 to 20 percent; allow expensing of capital investment; and permit repatriation of foreign income at a 5.25 percent tax rate (though repatriated income is exempt from taxation if it is invested in "manufacturers equipment").

This plan caters to the fetishistic political focus on giveaways to manufacturing.  An optimal code would reward job creating businesses regardless of their industry.  The radical differences between taxes for manufacturing and other activities would introduce perhaps the biggest and most damaging tax distortion in American history.  It would also invite endless fraud.   As I type this piece, I am manufacturing sentences, am I not?  Shouldn't my income be taxed as manufacturing?

What would be the deficit effect of this reform? In 2008, the estate tax netted $25 billion in revenue, while corporate income tax from manufacturing gathered $74 billion. Eliminating these taxes outright would cost the government $100 billion per year. By a conservative estimate of the personal income tax rate reduction (assuming the 28 percent rate applies to all income that was previously taxed at rates at or above 28 percent and the 10 percent rate applies to income previously taxed between 10 and 25 percent), the Santorum reform would have cost the government $285 billion in 2008. The tax exemption increase for dependent children would decrease revenue still further-assuming a 15 percent average tax rate for exempt individuals, this policy would cost more than $60 billion. Eliminating the AMT would have cost $76.4 billion in 2008, according to the Tax Policy Center (and much more in future years). And lowering the estate tax to 12 percent would shave another $15 billion in revenue.

On the back of the envelope, these provisions alone would reduce revenue by $550 billion per year. There are several policies not estimated here, some of which would be significant. The shift in resources toward manufacturing and away from other sectors with higher taxes would lower growth, decrease employment, and cause a massive reduction in tax revenue. The dramatic difference in marginal tax rates between corporations and pass-through entities would cause many pass-throughs to incorporate, especially in the manufacturing sector, further increasing the revenue loss. And allowing 100 percent expensing by corporations would also dramatically reduce revenues. All told, the total revenue loss would be at least $700 billion dollars a year, and perhaps as much as $10 trillion over a ten year budget window. While all the Republican tax plans lose some revenue, presuming to make up for it in spending cuts and growth effects, this staggering sum certainly rises to the level of implausible given the current budget situation. 

I am a growth optimist, and am sure that the true cost of his plan would be far less than my back of the envelope calculation suggests because a surging economy would lead to increased revenues.  But the static scoring exercise just sketched is a taste of things to come for Santorum.  The sad fact is that no serious individual would ever spend any effort trying to get such a thing through Congress.  It is just not a defensible plan.

Santorum has some good ideas-lowering the corporate tax rate, reducing the number of income tax brackets, and expensing capital investment, to name a few.  But the massive distortion introduced to favor manufacturing, and the social engineering from radically higher exemptions are horrible tax policy.

Kevin A. Hassett is a senior fellow and director of economic policy studies at AEI.

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