The Promises and Pitfalls of the GOP Tax Reform Framework

The Republican framework for tax reform was released Wednesday. As expected, we don't have much details, but it gives us a good idea about how the "Big Six" are thinking.

There is a lot to like in this plan: It reforms the corporate income tax system, it reduces the tax rate for small businesses and S-corps, it simplifies the tax brackets on the individual side of the code from seven to three, it eliminates some of the tax exemptions which are both a handout to special interests and make the tax code complex and unfair. The bottom line is that, if implemented, it would be an improvement of our tax code.

For better and for worse, it is a fairly traditional and conservative plan in the end. Here are my three favorite and three least favorite parts.

My three favorite things:

1. It cuts the corporate income tax rate from 35 percent to 20 percent. If you have your eyes on more economic growth, cutting the corporate income tax rate is the way to go. Currently, the United States has the highest corporate income tax rate of all industrialized countries of the OECD. While other countries reduced their rate over the last two decades, the U.S. tax burden went up. It has been terrible for U.S. companies' competitiveness but also for American workers. It's not often mentioned, but most the burden of the corporate tax falls on workers in the form of lower wages. That's because corporations don't pay taxes -- only people do. Also, globalization and the mobility of capital has allowed owners of that capital to make arrangements to avoid shouldering the brunt of the tax. For all these reasons, cutting the corporate tax rate is an incredibly good development, even though I wish they had called for a 15 percent rate or lower.
2. The framework moves to a territorial tax system. Currently we are one of the few industrialized countries to have a worldwide tax system. It means that, in theory, no matter where you earn your income as a corporation, you will be subjected to Uncle Sam's heavy hand and its 35 percent rate. Companies can avoid paying that much tax on their foreign earned income if they keep that income abroad. It means that the tax code is preventing many of them from investing back into their business and workers in order to avoid the high tax rate in the U.S. That, too, is a tremendous benefit of this plan.
3. The framework promises to "simplify the tax code," by "eliminat[ing] most itemized deductions," including, it seems, the state and local tax deductions on the individual side and the domestic production activities deductions on the corporate side. These are special interest handouts that make the tax code more complex and unfair. Talking about good terminations, I should note that the framework would also get rid of the Alternative Minimum Tax and the Death Tax. That's great.

My three least favorite things about the framework:

1. It promises to expand the child tax credit. This is pure politics and bad policy. Indeed, this tax preference is a darling of the conservative movement and it is a good example of the fact that conservatives can be very much in favor of big government policies if they serve their social goals. The child tax credit should be killed, not expanded. For one thing, it is the kind of social engineering through the tax code that we often claim we hate when Democrats are doing it. In addition, it is a refundable credit, meaning that some taxpayers below a certain level of income receive some money back. According to the Tax Foundation getting rid of it would save $710 billion over 10 years. That gives you an idea of how much it will cost to expand it. It also ignoring that policy aimed at caring for children is not best achieved through these tax preferences. Finally, it doesn't grow the economy. The bottom line: it's a problem.
2. The plan misses on a great opportunity to repeal or cap the home mortgage interest deduction, the charitable deduction, the tax credit for higher education, and a few other obvious handouts for special interests. There is no good reason to keep these expensive and counter-productive deductions which are expensive and do not grow the economy -- often they don't even encourage the behavior they hopes to intend to.
3. There is no way this bold plan doesn't grow the deficit in the short- and long-term. We are $20 trillion in debt already and that's only the beginning. We must pay for this tax plan with spending cuts. Unfortunately, as we know, this administration and the Republican congress aren't interested in reforming the drivers of our future debt. Unfortunately, no matter how much economic growth this tax plan unleashes, it won't be enough to get us out of the fiscal mess we are in. Without spending cuts, these tax cuts likely exacerbate our debt problem.

Obviously, this is an opening bid and the final product may be much better or worse than what is outlined in this framework. But so far, so good.