Magazine | July 6, 2015, Issue

Judging Lee-Rubio

A tax plan and supply-siders

Of the top three candidates for the Republican presidential nomination, judging from the RealClearPolitics average of national polls, only one has released a detailed tax plan: Marco Rubio, the senator from Florida. Not surprisingly, then, his proposal — made along with Senator Mike Lee of Utah, who proposed an earlier version of it on his own — has become the focus of the party’s tax debate.

When New Jersey governor Chris Christie, currently in eighth place in that average, outlined his own plan, the editors of the Wall Street Journal praised it by saying it was better than Rubio’s. Stephen Moore, writing in favor of a flat tax in The Weekly Stan­dard, included an aside blasting the Rubio plan.

This could be a useful debate for conservatives — if it is conducted on accurate premises. Judging from the press coverage, so far it has not been. The real flaws of the Lee-Rubio proposal are being obscured by misguided criticisms.

The Los Angeles Times, for example, reports that Rubio is trying to alter “party orthodoxy” on taxes by moving away from cutting the top income-tax rate: “Rubio’s plan tests whether Re­pub­lican primary voters are willing to go beyond that supply-side view.” Po­li­ti­co claims that Rubio is “running on a tax plan that tosses out decades of GOP allegiance to the idea of simply slashing rates across the board and expecting faster economic growth to follow.”

Such descriptions may hurt Rubio by making him look out of step with his party, or help him by making him look fresh and new. But they are false. Re­pub­li­can tax policy has never been purely about supply-side tax-rate cuts to spur economic growth. Especially when it has been politically successful — when it has actually changed tax policy — the GOP has combined supply-side tax-rate cuts with tax relief that puts money in middle-class families’ pockets. Rubio’s plan is squarely within that tradition.

Supply-side economics has often been criticized, unfairly, as a cover for plutocratic interests. That’s because a particular concern for the tax rate paid by the very highest earners is built into its logic. They pay the highest, and therefore the most distortionary, rate. They are the ones who are most responsive to changes in their incentives to work, save, and invest.

And there’s another feature of a progressive income tax that requires a little unpacking: The top rate is the only one that acts as a marginal tax rate on every person who pays it. Let’s say you cut only the 15 percent tax rate that applies to married couples making between $18,000 and $74,000 in taxable income. Making it 10 percent would improve those couples’ incentives to work: Now instead of keeping 85 cents of every extra dollar they earn from the IRS, they would keep 90 cents, an increase of about 6 percent. But every couple that makes more than $74,000 would get the benefit of that tax cut, too, pocketing an extra $2,800 — and their incentives to earn would not have changed at all, because all of their earnings above that threshold would continue to be taxed at the same rates as before.

That’s fine if the goal is to let people keep more of their money. But if the goal is to maximize the effect of a tax cut on incentives — if the tax cut is to be judged, that is, on supply-side terms — then the top rate is the one that most needs lowering.

All of this helps to explain why, when he evaluated the Reagan tax cuts in his book The Growth Experiment, Lawrence Lindsey concluded that the reduction of the highest income-tax rate — it went from 70 percent at the start of Reagan’s term to 28 percent at the end of it — had resulted in additional revenue, but the reduction of low-end tax rates had lost revenue. It’s why some supply-siders groused that George W. Bush’s reduction of the lowest tax rate was a waste of money. And it’s a large part of the reason that many supply-siders are enthusiastic about flat-tax proposals that would bring the top tax rate down a lot while raising the lower tax rates.

But Republican presidential nominees have never run on such proposals. They have never taken the only goal of tax policy to be maximizing economic growth while yielding a targeted level of revenues. Reagan could have offered a tax cut as large as the one he did while cutting the top rate much more, if he had left the lower tax rates alone and let bracket creep (whereby inflation pushed people into higher tax brackets) continue. But he wanted to cut middle-class taxes, he wanted a plan that could be enacted, and he wanted to be elected and reelected. So he offered across-the-board reductions in tax rates and an end to bracket creep.

The Republicans running for Con­gress in 1994 again offered middle-class tax relief in their Contract with America: Its major tax proposal was the creation of a $500 tax credit for children. In 1997 that proposal made it into law, paired with a capital-gains-tax cut. George W. Bush, running for president in 2000, also combined supply-side and middle-class tax cuts. He cut the capital-gains, dividend, and estate taxes and the top income-tax rate; he also cut most of the other income-tax rates and increased the tax credit for children to $1,000.

The Lee-Rubio plan, too, has supply-side elements. It eliminates the taxes on capital gains, dividends, and estates, and the alternative minimum tax. It cuts the top income-tax rate. It cuts the tax rate on business income and allows businesses to write off the expense of investments immediately. But it also has two major middle-class-friendly features: It expands the child credit, adding $2,500 to it and applying it against payroll taxes as well as income taxes. (The senators say the credit is necessary to correct for the way entitlements overtax parents, who contribute extra to the programs by raising children.) And it taxes a lot of income that now falls in the 25 percent bracket at 15 percent.

What isn’t new in the plan, then, is that it includes tax cuts other than tax-rate cuts, that it is not just a list of supply-side priorities, and that it expands the child credit. Politico noted that lowering the top tax rate from 39.6 to 35, as Lee-Rubio does, still leaves it “far higher than many Republicans would like.” That’s true, but it also leaves it in the ballpark of previous Republican proposals. It’s the rate George W. Bush and congressional Republicans enacted in 2001. We have had a top tax rate lower than 35 in only five of the last 80 years — and in those years, investment was taxed more heavily than it would be under Lee-Rubio.

Some supply-siders argue that Lee-Rubio should have proposed bringing the top tax rate still lower, which would do more to improve incentives to work, save, and invest, and thus encourage growth. The Journal prefers Christie’s top rate of 28. But this lower rate would not be likely to have a large economic effect. First, we should expect diminishing returns. When Reagan cut the top rate from 70 to 50, the after-tax return on a dollar earned rose 67 percent. Cutting the top rate from 35 to 28 would raise it only 11 percent.

Second, Republicans have repeatedly overestimated the growth effects of income-tax rates — predicting a bust when Clinton raised taxes and a boom when George W. Bush lowered them. Neither occurred, and in fact growth rates were better under the higher Clinton income-tax rates than under the lower Bush ones. Any positive effect of lower tax rates on growth are small enough that other factors can overwhelm them.

Third, it’s not clear that getting the rate on high earners so far down is politically realistic. A tax package that combined some reduction in the top rate with tax cuts that directly benefitted the middle class would almost certainly stand a better chance of enactment. That is, after all, how such tax-rate reductions have been achieved before.

Lee-Rubio does not break precedents, then, in its approach to the top tax rate. But other aspects of the plan are genuinely new. Over the last generation the payroll tax has become a bigger burden for the middle class than the income tax, but Republicans have generally left the payroll tax alone. Mitt Romney, for example, offered an across-the-board reduction in income-tax rates, but middle-class income-tax liability is too low for it to have helped people as much as previous proposals in that vein. Lee-Rubio reduces ­payroll-tax liabilities for many people.

Lee-Rubio is also a bigger tax cut than most previous proposals: The Tax Foun­dation estimates that it would reduce federal revenues by $4 trillion over a decade unless it raised economic growth. Some Republican-primary candidates have run on zeroing out taxes on capital gains and dividends, but no nominee has. The proposed treatment of business is new, too, and reflects an increased concern about competition among countries for capital investment. And the child-credit proposal is also much larger than previous candidates have suggested.

Finally, Lee-Rubio raises taxes on some people. Single people making more than $75,000 and married people making more than $150,000 a year would pay a 35 percent tax rate on income above that amount. These are high earners: The Census Bureau reports that in 2013, the median income for married couples was $76,000. Many of these high earners are now in the 25, 28, and 33 percent brackets, so mar­gin­al tax rates would go up on them. A good many of them would, however, have lower total tax bills. Take a couple making $200,000 a year. The new rate structure in Lee-Rubio would leave them ahead: They would save more from the lower taxes on income between $75,000 and $150,000 than they would pay from the higher taxes on income above that level. They would come out even farther ahead if they had children.

Republican tax reforms have sometimes proposed raising tax rates and tax bills for some people. Most flat taxes, for example, would raise taxes on many more people (and on people with lower incomes) than Lee-Rubio would. Re­pub­li­can nominees, though, have usually avoided proposing tax increases on anyone.

We don’t yet know how the plan will play in the 2016 elections. Most Republican-primary voters have not been supply-side purists, which is why nominees have not been either. Voters might find the $4 trillion impact on revenues too large. And the combination of raising taxes on some affluent households while also nearly eliminating income-tax bills for wealthy people who derive most of their income from investments seems politically problematic, to say the least. Proposing to end the capital-gains tax, as opposed to cut it, was unwise: If it was meant to buy supply-side support for the plan, it has not worked. (The Journal hardly mentions that feature of the plan when it de­nounces it.)

The problem with Lee-Rubio, in other words, isn’t that it breaks with the Republican party’s supply-side traditions; it doesn’t. The problems are that it pursues supply-side goals on investment taxation too avidly, and that it’s too large. Put the plan on a diet and both problems are solved.

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

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