The Corner

Taxing Capital and Labor

Americans for Tax Reform and the Conservative Reform Network hosted a tax-policy discussion with representatives of several Republican presidential campaigns this morning. It was illuminating but not especially combative: The speakers stressed that their plans had a lot in common.

Stephen Moore, the prominent libertarian economist, made two interesting points. He was there to defend Rand Paul’s plan even though he is not with the senator’s campaign. The first is that flat-tax plans cannot just reform the income tax: They have to deal with the payroll tax too. If you flatten the income tax while leaving the payroll tax alone, you let high earners pay a lower marginal tax rate than people lower on the income scale. That’s because the payroll tax is capped, currently at $117,000. Paul’s plan, like Ted Cruz’s, would get rid of the payroll tax. So there would be no progressive income-tax rate structure, but also no payroll-tax cap. In both plans, the payroll tax and the corporate-income tax would be replaced by a value-added tax.

Moore’s argument that a flat tax has to cover both the payroll and income taxes is persuasive, although it creates a thorny problem for Social Security—since the existing benefit structure is tied to payroll-tax payments. (The tax is capped, for example, because benefits are too.)

I thought he was less persuasive on a second point. He suggested that the Paul plan (and by extension the Cruz plan) avoids a political vulnerability of many Republican plans because it taxes capital and labor at the same rate. He made this point in the context of the controversy over whether carried interest should be taxed at the labor rate or the capital-gains rate: If they’re the same rate, there’s no need to choose. The problem here is that these plans don’t really tax capital and labor at the same rate. In Paul’s plan, for example, capital gains would be taxed at the 14.5 percent income-tax rate, but wages would be taxed at that rate while also being subject to the 14.5 percent value-added tax. The total tax rate on labor would be 26.9.

I believe this differential treatment is defensible, but I’d expect Democrats to point it out if a Republican nominee ran on a plan like Paul’s or Cruz’s—and also to point out that even though the plan gets rid of the payroll tax, cap and all, it raises effective marginal tax rates on a lot of the middle class while lowering it on high earners.

(disclosure)

Update: On second thought, an aside I made above isn’t really true, so I’ve deleted it.

Ramesh Ponnuru is a senior editor for National Review, a columnist for Bloomberg Opinion, a visiting fellow at the American Enterprise Institute, and a senior fellow at the National Review Institute.

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