Dave Camp, chairman of the House Ways and Means Committee, has done something extraordinary. He has developed a credible, revenue-neutral tax reform proposal that improves work incentives in a meaningful way. And according to the Joint Committee on Taxation, Camp’s Tax Reform Act of 2014 (TRA) will yield a substantial increase in economic output over the next decade ($3.4 trillion) and as much as $700 billion in new “dynamic” revenue flowing from increased incomes across households and firms. The Wall Street Journal editorial page approves, apart from an unwarranted dig at the child tax credit, one of the better conservative policy innovations of the past generation.
Some on the right see Camp as the skunk at the garden party. GOP prospects for winning a majority in the U.S. Senate are improving markedly, due to persistent dissatisfaction with the Obama administration, the failures of Obamacare, and a combination of the recruitment of a surprisingly strong cadre of Republican candidates and the retirements of a number of formidable Senate Democrats. Many Republicans are thus skeptical about the wisdom of releasing a detailed tax reform proposal this close to the midterm congressional elections, as there is a concern that it might distract attention from an unpopular president and his unpopular health law. Moreover, there is a real risk that the proposal might divide Republicans, some of whom might find it awkward or difficult to defend some of its more controversial provisions, like its (extremely modest) trimming of the mortgage interest deduction and the charitable contribution deduction, among others. On Wednesday, Speaker John Boehner was extremely dismissive of the notion that Republican lawmakers would rally around the Camp plan, and he described it as the start of a conversation. One has to assume that Camp, who has toiled over the proposal for years, and who will surrender his role as chairman of Ways and Means after the midterms, wasn’t entirely pleased by Boehner’s performance. But leaving Dave Camp’s feelings aside, he has done all Republicans a great service by clarifying the tradeoffs involved in reforming the tax code. And more than that, he has offered a shrewd template for how conservatives ought to approach ambitious reform efforts.
The most politically attractive aspect of the Camp plan is that though it improves work incentives for (most) high-earners, it is notably friendly to middle-income households. Its mortgage interest deduction will continue to benefit virtually all homeowners, with the exception of a small number of affluent families, most of whom reside in capacity-constrained regions where the main effect of the mortgage interest deduction is to drive up prices, thus making housing less rather than more affordable. Middle-income households will also reap the benefits of simplification, as the increase in the standard deduction will spare 95 percent of households from the need to itemize their taxes. The TRA increases the size of the child tax credit, indexes it to inflation, and increases its refundability rate. Though conservatives ought to consider a child tax credit that is larger still, this is a measure that will (modestly) ease the tax burden on middle-income parents who are making large investments of time and money in their children’s human capital, and Camp deserves credit for including it. Yet his proposal also trims the size of the earned-income tax credit, a subject that Patrick Brennan will address in greater detail.
While the vast majority of households will see a net tax cut, the most affluent households will see an increase, albeit an increase that will still leave them with improved work incentives. TRA phases out a number of tax benefits for single filers earning $250,000 or more and joint filers earning $300,000 or more; yet it is worth remembering that tax units earning over $200,000 represented 4.2 percent of all tax units in 2011. Cleverly, the TRA also phases out the 10 percent bracket at this level. This won’t actually dull the work incentives of high earners, as their work effort depends on the marginal tax rate applied to the last dollar of income they earn. When you increase the top tax rate, you reduce work incentives for the highest earners as much as you would if you increased the tax rate on their entire income, despite the fact that you’re only raising taxes on a portion of their income. By phasing out the 10 percent bracket for high-earners, the TRA recognizes and takes advantage of this dynamic — raise revenue in a way that doesn’t reduce work incentives; use the revenue to finance a rate reduction that improves work incentives. One of the biggest changes the TRA introduces is in its treatment of capital gains and dividends. The upshot is that capital income will see a slight increase in taxes, which isn’t ideal, but which might be politically necessary. (Robert Stein’s National Affairs essay on “Taxes and the Family” envisions tax rates on capital income that are broadly similar to the effective rates in the TRA.) The TRA also treats carried interest as ordinary income, an idea that Avik Roy has criticized in this space. Specifically, Roy warns that higher tax rates on carried interest will encourage short-term investing over long-term investing, thus exacerbating a short-term bias that Clayton Christensen has identified as the central problem plaguing the U.S. economy. Others believe that this concern is overstated, and that treating carried interest as ordinary income is a matter of simple fairness. If nothing else, Camp is certainly playing against type as a conservative Republican who favors this step.
Later on, we’ll discuss Camp’s approach to corporate tax reform and how it stacks up next to various other proposals. For now, I’ll close by observing that Camp has been careful to protect the interests of middle-income taxpayers in his new tax reform proposal, and that is the first and most important test any conservative tax reform proposal will have to pass.