Are some Republicans unrealistic about how low tax rates can go?
The next American president will preside over a federal government — according to CBO — taking in revenue equal to 18% of GDP yet also running budget deficits averaging 3% of GDP — not to mention a national debt twice the pre-Great Recession level. If that president wants to cut top individual income tax rates, how low can he or she realistically go given the budget situation?
The numbers 25% or 28% often get tossed around by Republicans as desirable top rates. Both certainly have symbolic oomph. The former was the top rate under President Coolidge, while the latter was (sort of) the top rate established by the 1986 tax reform. But are rates that low — the top rate has only been 28% or lower a total of 14 years since 1913 — fiscally realistic?
Not without base broadening, eliminating or curtailing various breaks and using the resulting revenue to lower those statutory rates. (And as the Romney tax plan in 2012 shows, base broadening is no piece of cake.) That’s how the 1986 tax reform was done. But that “cut the rate, broaden the base” approach may not have been an economic game-changer. AEI’s Alex Brill and Alan Viard:
Because the Tax Reform Act of 1986 dramatically reduced statutory tax rates, including the top rate from 50 to 28 percent, many observers concluded that it would reduce work disincentives. As Alan Auerbach and Joel Slemrod noted, though, because the rate reductions were offset by base broadening, the reform left effective tax rates and work incentives roughly unchanged for the economy as a whole, although it significantly raised or lowered disincentives for particular taxpayers.
Also note that the big tax reform plan of House Ways and Means Chairman Dave Camp, which also followed the 1986 formula, only managed to reduce the top rate to 35%.
Of course, you could slash rates without base broadening and accept lots less revenue — which would almost certainly be the result even with reasonable dynamic scoring. (And any Laffer Effects are much less when bringing down the top rate from 40% than from 70% back in 1981. Top income tax rates are not on the “wrong” side of the Laffer Curve today.)
But then you would have to cut spending — likely entitlement or other safety net spending, as well a discretionary spending — to avoid enlarging an already large debt and deficit. Good luck pushing tax cuts financed by Medicaid, Medicare, Social Security cuts. Indeed, it seems more politically likely major entitlement reform would be accompanied by tax hikes, not tax cuts. AEI’s Viard and Michael Strain:
… entitlement reductions will be part of the fiscal solution, and the most growth-friendly approach to fiscal consolidation would go heavy on spending cuts and light on tax increases. But public and political attitudes make it clear that it will be possible to secure significant entitlement reductions only if they are accompanied by tax increases. Democrats’ opposition to entitlement cuts and Republicans’ ambivalence about them make a budget strategy that relies entirely on entitlement cuts politically unviable.
Therefore, revenue will have to rise to restore fiscal balance. Indeed, the only significant entitlement benefit reduction in recent years, the benefit cuts in the 1983 Social Security legislation, were part of a bipartisan agreement that also included tax increases. … And Republicans are starting to accept this as well. Ryan’s budget proposal calls for revenue to rise to 19.1 percent of GDP by fiscal 2023, significantly above the 1960-2013 average of 17.9 percent.
Realistic tax reform — show your math, please! — should certainly be part of any pro-growth agenda. But there should be lots more to a pro-growth agenda than just lowering top rates: reducing regulatory barriers to startups, patent and copyright reform, and ending “too big to fail,” among others.
Follow James Pethokoukis on Twitter at @JimPethokoukis, and AEIdeas at @AEIdeas.
