President Trump’s latest tax-reform proposal gets some big things right. Our corporate tax rate is the highest in the developed world, and it reduces investment and therefore wages. He wants to bring it down. He wants to reduce marginal tax rates on individual income to improve incentives to work, save, and invest. And he would eliminate the deduction for state and local taxes, a deduction that both functions as a subsidy from low-tax states to high-tax ones and mostly benefits the affluent.
The proposal includes fewer details than the two tax-reform plans Trump released during the campaign, which is the reverse of the usual path for legislation. As those details are filled in, Republicans should attend to three elements of the plan.
First, the administration is silent about two important reforms to business taxation. Other Republican plans have advocated allowing businesses to deduct the cost of investments as soon as that cost is incurred, rather than making them use lengthy depreciation schedules to stretch out those deductions. They have also ended the tax code’s bias toward the use of debt rather than equity in financing investment. These changes to the business tax base are at least as important as reducing tax rates.
Second, legislation should structure in a sensible way the “tax relief for families with child and dependent care expenses” that the White House promises. During the campaign, Trump said that families with stay-at-home moms would benefit equally from this tax relief. The best way to achieve that objective would be to expand the tax credit for children and allow it to reduce payroll-tax as well as income-tax liabilities. Parents could use their additional take-home pay for commercial day care if they wish, but could also use it to allow mothers to work part-time instead of full-time, or to save for education.
Third, the legislation should not let revenues and spending get much further out of alignment. It was one thing to cut tax rates without much concern for deficits when the ratio of national debt to GDP was 30 percent, as it was in 1981. It’s another when it’s more than 100 percent, as now. Republicans say that tax cuts will provide a substantial boost to economic growth, and they may be right. But budget plans should not count on such future growth. Nor should they count on future spending restraint. The less Republicans are willing to restrain spending now, the more restrained their tax cuts should also be.
The Trump White House seems to be taking a more hands-off approach to legislation than most of its recent predecessors. It has set a direction for tax reform. How we move in that direction is now up to Congress. It can and should use this opportunity to combine pro-growth policies, middle-class tax relief, and fiscal prudence.