Spending Cuts Are the Best Way to Pay for Tax Reform

Sound tax policy does not single out particular businesses in certain industries for extra taxation.

Yesterday, Speaker Ryan promised that tax reform would happen before the end of 2017. My two cents is that it won’t until Ryan finally agrees to drop the border-adjustment tax that has fractured our movement, the business community, and the Republican caucus. As it stands, tax reform may not even be able to get out of the House, let alone the Senate (the White House is also skeptical of the border-adjustment tax). 

When Ryan does drop the border-adjustment tax (BAT), we can finally unite behind tax reform and look for alternative ways to get it done. As such, now is as good a time as any to remind the Republicans in charge of leading this effort that there’s a right way and a wrong way to move beyond the border-adjustment tax. Recently, Ways and Means chairman Kevin Brady, the most dogged proponent of the border-adjustment tax in Congress after Speaker Ryan, simultaneously admitted that the only function of the BAT is to raise revenue and suggested that dropping it may require Congress revisiting the revenue raisers in the Camp proposal (named after former congressman David Camp of Michigan), though Brady was quick to point out that he hoped it wouldn’t come to that. 

Perhaps this is Brady’s way of pressuring critics to just give up and accept the BAT because falling back on the Camp plan is a poor substitute for real tax reform. 

Like the current effort, Camp was hamstrung by a misguided insistence on “revenue neutrality.” Revenue neutrality means that the government continues collecting just as much in taxes after reform. While some may think it make sense in today’s high-debt environment, it is no solution to our debt and economic-growth problem. First, overspending is the driving cause of our giant debt and there is no amount of revenue that will address the explosion of our national debt that is caused by the entitlement-crisis wall into which we are heading very quickly. Second, revenue neutrality means that Congress is voluntarily deciding to tie its hand on what it can do to grow the economy through tax reform because lawmakers have to choose between lowering tax rates in exchange for increasing double taxation or reducing the tax burden on savings and investment in exchange for only slightly lowering rates. 

Granted, unlike Representative Camp in 2014, Republicans plan to finally use dynamic rather than static scoring — dynamic scoring takes into account the impact of tax reform on economic growth. However, CBO’s modeling still leaves a lot to be desired. So while they are trying to actually reduce the tax burden overall, they are still likely to overpay with revenue offsets. 

The revenue constraints placed on Camp forced inclusion of many bad ideas in his proposal such as increasing the tax bias against savings and investment by raising the tax rate on capital gains and “extending the length of the period over which businesses may deduct the cost of buying machinery or equipment and building factories or other structures,” as David Burton explained back in 2014. In that vein, and among other items, the plan randomly targeted advertising expenses for the sole purpose of raising revenue. Burton explains: 

The Camp plan would require that half of advertising expenses be deducted over a 10-year period. This entirely unwarranted provision would deny businesses the ability to deduct their expenses and thus overstate their taxable income. This provision would increase business taxes by $169 billion over 10 years. 

Why would the plan arbitrary treat advertising expenses differently than other business costs? I do not know. Advertising serves an important purpose in helping the economy function smoothly. It provides information to consumers and facilitates competition and entry of new products to the market. Moreover, the whole point of tax reform is to simplify the code and end distortions such as that. Oh and then there was this: 

One of the most egregious violations of sound tax policy in the plan is a tax on systemically important financial institutions (SIFI). The tax, better known as a bank tax, would apply to only a few of the largest banks and other financial firms — those with more than $500 billion in assets. The tax would be 0.035 percent on those banks’ assets, assessed quarterly. It would raise more than $86 billion over 10 years. Sound tax policy does not single out particular businesses in certain industries for extra taxation. If there are issues arising because of how other laws affect these banks, those issues should be addressed outside of the tax code. 

I would like to repeat this: “Sound tax policy does not single out particular businesses in certain industries for extra taxation.” 

In other words, falling back on the Camp reform pay-fors such as the few named above would be a step backward. There is no way that Republicans believe that these are are only two options for tax reform. They must know that a better approach would be to acknowledge fiscal reality and cut spending. Or not. An imperfect and partial alternative is to extend the budget window, as some are now considering. It would have the merits of better accounting for the positive economic impact of tax reform and lessening the need for counterproductive new taxes.