For much of the fall campaign, the major domestic-policy debate between the presidential candidates has concerned taxes. In that debate Obama has taken a position he probably does not believe, and Romney has defended a plan he probably won’t enact if he wins. Congress should go in a different direction from either candidate.
Romney has set forth many of the right goals for tax reform: He wants a tax code that is simpler and more pro-growth, with fewer deductions and lower rates, than the one we have now. Toward those ends he would cut all income-tax rates by 20 percent, cut the corporate-tax rate, eliminate the alternative minimum tax and the estate tax, and end taxes on investment income for everyone making less than $200,000 a year. He says he would scale back enough tax breaks that the new tax code would raise as much money, and as much money from people making more than $250,000, as the old one does.
Those final promises have been the subject of most of the debate, with critics saying that there aren’t enough deductions available to make them come true. Whether or not his plan is mathematically impossible, as they assert, it may not be legislatively possible. If Republicans take the Senate at all, they will do so narrowly — and Democrats seem less inclined to compromise on taxes than they were when a closely divided Senate approved George W. Bush’s tax cuts in 2001 and 2003. Republican voters nowadays seem less enthusiastic about tax cuts, too: Spending, the debt, and Obamacare are the topics of conservative conversation. The expiration of the Bush tax cuts at the end of this year also reduces the likelihood that Romney will deliver additional tax cuts: He will be hard pressed just to keep taxes from rising.
Conservatives should not be very disappointed that Romney’s tax plan seems unlikely to pass, because it isn’t a well-designed plan. The critics are right to say that there is no good reason for a plan to specify the tax rates and revenue levels for which it aims but not the tax breaks it would pare back. Nor is it urgent to reduce the top tax rate. Good supply-siders always want to make the top tax rate as low as possible, so as to improve incentives to work, save, and invest. Today’s top rate of 35 percent is, however, relatively low: For only five of the last 80 years has it been lower.
When Ronald Reagan cut the top tax rate from 70 to 50 percent, he increased the after-tax return on a dollar earned from 30 to 50 cents, or 67 percent. Cutting the top tax rate from 35 to 28 percent, as Romney proposes, would increase that return by only 11 percent. Cutting the bottom tax rates delivers even less economic gain. Taking the 10 percent tax rate to 8 percent increases incentives by 2 percent. As our tax code is structured, everyone passes through the bottom tax brackets before getting to the higher ones. So most people will get a bit of extra money from the reduction of the 10 percent rate — and tax revenue will correspondingly take a hit — but they will not see their incentives improve at all.
Cutting taxes on investment returns for people making less than $200,000 sounds like a nice way to promote saving and help the middle class, but it’s not very effective at either. People above that threshold are, not surprisingly, responsible for a disproportionate share of national saving. They should not be excluded if the goal is to increase it. Since taxes on returns to saving aren’t a major budget item for most middle-class households, their reduction also won’t do much to help them.
If you were designing an ideal tax code from scratch, you wouldn’t include the alternative minimum tax. Congress passed it out of concern that a small number of wealthy taxpayers were using tax breaks to pay nothing, or almost nothing, to the government. Instead of curtailing the breaks, they made these taxpayers calculate their liability under a second set of rules and pay whichever was higher. Over the years this second tax code has affected more and more people — and it would affect millions more if Congress didn’t regularly enact temporary “patches” to limit its reach. Repealing the AMT would mean a very large reduction in federal revenues, though, leaving less money available for deficit reduction or other tax cuts. Given the existence of other priorities, the AMT should probably be scaled back but not repealed.