The Corner

The Downside of Fantasy Tax Plans

Ramesh Ponnuru and the tag team of Amity Shlaes and Matthew Denhart have been engaged in a spirited debate (here, here, and here) over the merits of the Mike Lee-Marco Rubio tax plan. Ramesh for, Shlaes-Denhart against. Shlaes and Denhart would prefer the plan lower the top marginal rate more deeply – from 40 percent to 20 percent or perhaps all the way – instead of Lee-Rubio’s 35 percent top rate and a greatly expanded child tax credit.

Ramesh is at great disadvantage here. He is defending a tax plan created to operate in 21st century America — bound by the political, economic, and fiscal realities therein – and address modern problems, including slow economic growth and stagnant family incomes. Shlaes and Denhart are limited by no such restrictions as they argue for a more idealized, theoretical approach, one infused with nostalgia for a pre-New Deal, pre-Fed, pre-income tax America. When thinking about real-world tax policy, here are some things to keep in mind, as I noted in a column this week:

First, the top personal income tax rate has bounced up and down for more than 30 years, and growth has actually been faster when it’s been on the higher side. From 1982 through 1986, the top rate was 50 percent, and real GDP growth averaged 3.5 percent. From 1986 through 1992, the top rate was 31 percent, and growth averaged 2.8 percent. From 1993 through 2001, the top rate was 39.6 percent, and growth averaged 3.6 percent, And from 2002 through 2012, the top rate was 35 percent, and growth averaged 1.8 percent. Where there other things going during those years besides tax-code tinkering? Of course. Correlation and causality are tricky to prove with a big complicated beastie like the $17 trillion U.S. economy. But simply assuming a lower rate will create hypergrowth is a stretch. What’s more, voters won’t believe it either.

Second, it’s hard to get faster — much less “explosive” — GDP growth these days, because America is getting older. An economy with slowing labor force growth needs higher productivity to generate the same output. And boosting productivity requires a lot more than just tax reform. Just returning long-term GDP growth to its postwar average would be a major accomplishment.

Third, even if deeply cutting the top tax rate did boost growth, it might not help most households. The Federal Reserve reports that while the average pre-tax income for the wealthiest 10 percent of U.S. families rose from 2010 to 2013, there was little change for middle-class families. During that same period, real GDP rose by 9 percent. Automation and globalization may be decoupling middle-class living standards from GDP. Cranking up GDP growth is necessary for American prosperity, but not sufficient. 

Fourth, even dynamic scoring probably won’t make the budget numbers work for low-rate tax plans unless they also raise taxes on the middle class or cut entitlements. Back in 2012, Newt Gingrich had a 15 percent flat-tax plan that the Tax Policy Center scored as losing $1 trillion a year.

The aspirational must not bleed over into the fantastical. In addition to poor policy, it makes for a weak, untenable negotiating position and sets up your own team for massive and chronic disappointment.

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