Ryan’s tax plan trumps his spending plan

Ike Brannon Ike Brannon is president of Capital Policy Analytics, a consulting firm in Washington, D.C.
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Paul Ryan’s 2012 budget resolution, entitled The Path to Prosperity, contains two separate pieces — a spending reform plan and a separate tax reform component. While the spending plan has been getting most of the attention — and vitriol — the tax plan may be the most important component of his blueprint, for it promises to deliver higher economic growth and concomitant tax revenues, a combination that the administration knows must be achieved to fix our current debt crisis. Given the president’s stated intention to proceed on some sort of tax reform before the election, Ryan’s tax proposals may be the most durable portion of the proposal.

Ryan’s tax plan has four key planks that should appeal to politicians on both sides of the aisle, as they ultimately boost economic growth, generate more tax revenue, and make the tax code more progressive at the same time:

It keeps taxes on capital income low. This is vitally important because taxing dividends and capital gains depresses savings, investment, and economic growth more than any other tax we have. Nobel Laureate Robert Lucas has said that he believes reducing or eliminating altogether these taxes is as close to a free lunch as there is.

It addresses the pernicious effects of tax expenditures. Over the last two decades, wily members of Congress have figured out that it is much easier to provide favors to constituents and friends via the tax code than through government subsidies. Today, this largesse — what we call tax expenditures — represent over $1 trillion in foregone revenue. Many of these loopholes in the personal income tax code add nothing to economic growth and effectively transfer the tax burden from the upper class, so scaling these back adds progressivity to the code — a stated goal of Obama’s.

Ryan has yet to specify reductions in tax expenditures because he can’t step on the toes of the tax-writing committee and Ways and Means Chairman Dave Camp. Both know that Obama will demagogue whatever choices are made along those lines. If Obama says he’s ready to jump off the cliff, they will have to hold hands and propose cuts that are bound to be objectionable, such as a scaling back of the mortgage-interest deduction.

It lowers tax rates on all businesses to 25 percent. U.S. businesses face the highest corporate tax rate in the developed world. A lower tax rate on businesses makes it easier for them to compete globally and create jobs here, a point that the administration refuses to acknowledge as they pretend that a U.S. business operating abroad takes jobs away from this country. The reality is that if a company such as Caterpillar opens an overseas factory to produce tractors, it is doing so mainly to service overseas markets, where its presence creates all kinds of ancillary jobs back in the U.S.

It acknowledges the role of economic growth in generating tax revenue. The primacy of economic growth in generating tax revenue cannot be overstated: the fastest post-war increases in tax revenue growth occurred in 1997-2000 and 2004-2007, when revenues went up by nearly 50% in each instance. Tax rates did not go up at all during that time — the rapid increase in revenue occurred because we were in a sustained period of strong economic growth. While Ryan’s tax proposal does not appreciably change the tax burden on small businesses and upper-income taxpayers, his one-two dance step of lowering tax rates while reducing tax expenditures is a tradeoff that would greatly boost economic growth.

The Ryan tax plan’s few flaws lie in its timidity. A repeal of Obamacare should be accompanied by a further expansion of the legislation’s partial tax exclusion of high-value employer-provided health insurance plans. Excluding employer-provided health insurance from taxes is highly regressive and creates an unhealthy bias towards more expensive health insurance, helping to drive up health care costs. Of course, Obama shamelessly attacked John McCain’s proposal to eliminate this exclusion even though his chief economic advisers had endorsed just such a plan before the campaign, and he backtracked as soon as he won the election.

And while few would dispute that corporate tax reform is necessary, the “carve outs and deductions” on the corporate side of the tax code that Ryan proposes to eliminate to pay for a lower tax rate represent more than just special favors for corporations: they include a number of provisos designed to encourage investment in the United States, such as the Research and Experimentation Tax Credit. Higher investment leads to increased productivity, economic growth, and income, and ultimately higher tax revenue as well. Ryan’s right in that we can no longer afford to have the highest corporate tax rate among the developed economies, but we cannot penalize U.S. companies at the same time we are trying to make them more competitive. To be sure, some loopholes do need to be abolished, but others need to be reformed and strengthened.

A return to fiscal solvency requires not just spending discipline and entitlement reform but also a revamped tax code that encourages work, savings, and investment — the ingredients to strong economic growth. And without strong economic growth it will be impossible to come to grips with our budget chasm. Paul Ryan’s tax plan lays down a foundation to achieve precisely that.

Ike Brannon is Director of Economic Studies at the American Action Forum.