House GOP's new tax plan

Three interesting ideas in the House GOP's new tax plan—and one red flag

By Danny Vinik

On Friday, House Republicans released the sixth and final piece of their policy agenda: a comprehensive tax plan. Their 35-page report on tax reform would cut the number of tax brackets, eliminate numerous tax breaks and dramatically transform the corporate tax code.

It’s a serious document, and contains several provocative new proposals and plenty of credible ideas, a sharp contrast to the tax plan released by Donald Trump that would cut taxes by more than $10 trillion over the next 10 years.

Some of the ideas are standard conservative talking points, like cutting the corporate tax rate from the current 35 percent rate to 20 percent (this is new only in that it’s five percentage points lower than many pervious Republican tax proposals). But a number of the ideas will challenge tax orthodoxy on both sides of the aisle, challenging both liberal and conservative tax wonks who have specific ideas for what a reformed tax code should look like. This could pave the way for a grand tax compromise down the road, the kind of deal that reformers are hoping for—but it also contains one big problem.

Here are three interesting ideas in the GOP proposal—and one red flag:

1. Supply-siders take a hit. It’s longstanding GOP orthodoxy that we need to cut the top individual tax rate dramatically from its current rate of 39.6 percent. The supply-siders who take this view, long dominant in GOP tax circles, have been challenged by a new breed of tax reformers, led by Sens. Mike Lee (R-Utah) and Marco Rubio (R-Fla.), who propose an increase in the Child Tax Credit with smaller cuts to the individual rate.

The GOP’s new proposal sharply breaks with supply-siders, cutting the top individual rate to just 33 percent, with two other brackets at 25 percent and 12 percent. (The plan does not specify the income thresholds for those rates, but says that “no income group will see an increase in its federal tax burden.”) While 33 percent is still a big cut, it comes nowhere close to what supply-siders have proposed. Ryan’s budget for the 2015 fiscal year, for instance, suggested two tax brackets with rates at 25 percent and 10 percent.

This might reflect a new political reality, where Republicans no longer focus their attention solely on cutting the top tax rate. It certainly doesn’t come close to a flat tax, which Stephen Moore, a godfather of supply-side tax theory, recently called the “holy grail of tax policy.” Perhaps that was the old GOP.

2. 47 percent and rising. One of Mitt Romney’s worst moments in the 2012 presidential election came when Mother Jones released a video of him at a private fundraiser writing off 47 percent of Americans as freeloaders on the government because they pay no federal income tax. It’s a tendentious claim, since those American pay plenty of other U.S. taxes, including payroll and state and local taxes. But conservatives have long held up the talking point to demonstrate that too many Americans are skimming off hard-working taxpayers. To fix this, for instance, Ben Carson’s tax plan called for all Americans with income below 150 percent of the poverty line to pay a “de minimis tax.”

The House GOP’s tax plan goes in the exact opposite direction: it increases the number of Americans who don’t pay federal tax by raising the standard deduction. The current standard deduction is $6,300 and personal exemption is $4,050 (double for married couples). That means any American earning $10,350 or less will have no federal tax liability, before factoring in other tax breaks including the Child Tax Credit and Earned Income Tax Credit. The new proposal eliminates the personal exemption and increases the standard deduction to $12,000 for individuals and $24,000 for married couples. That increase will very likely lead to fewer Americans paying the federal income tax—so the 47 percent statistic would go up.

3. A progressive capital gains tax. One of the more interesting proposals in the GOP tax plan relates to taxes on investment income. Republicans have long proposed reducing taxes on investment income—interest income, dividends and capital gains—because that income is taxed twice; first, as individual labor income and second, as investment income. Rubio went so far as to call for the elimination of the capital gains tax, which currently is 23.9 percent.

The House GOP plan doesn’t go nearly as far; it does cut the rate, but only to 16.5 percent. It also offers an unusual twist: it creates a progressive capital gains structure, so that the rich pay a higher rate on their investment income than the poor. Here’s how it works: Investment income is officially taxed at the standard individual rates—12 percent, 25 percent and 33 percent— but Americans will be able to deduct 50 percent of their net capital gains, dividends and interest income. That effectively creates three tax brackets for capital gains at 6 percent, 12.5 percent and 16.5 percent.

However, the tax proposal isn’t likely to make much, or any, indent on inequality since investment income accrues almost entirely to the rich. The Congressional Budget Office reported that in 2013, the top 20 percent of earners received 93 percent of the benefits of the preferential rate on investment income. The bottom 40 percent received none of the benefit.

So while progressive tax rates on investment income appear to be an interesting idea at first glance, in effect, the plan simply acts as a traditional tax cut.

4. The red flag: Sketchy math on the deficit. The House GOP declares that its tax proposal is “fiscally responsible” and revenue neutral, meaning it won’t decrease the money the government takes in from taxes. But it includes a few magic asterisks to make that happen.

The Congressional Budget Office projects that the federal government will collect $42 trillion in revenue over the next 10 years—this is the “baseline” of revenue that tax plans are traditionally compared to. For the GOP tax plan to be revenue-neutral, it would have to raise $42 trillion, right? Not exactly. The Republicans, in their plan, adjust the baseline to make it easier to hit. Here’s how: Under CBO projections, a variety of tax breaks will expire over the next 10 years, increasing revenues by $400 billion. Republicans say that Congress isn’t likely to let those tax breaks expire, so the $42 trillion baseline effectively overestimates the revenues by $400 billion. So instead of using that, they use what’s called a “current policy” baseline that is $400 billion lower. It’s a small reduction—and not an unreasonable one, given that Congress is all but certain to extend many of those tax breaks—but it helps Ryan and Co. reach the goal of revenue-neutrality.

The plan also does not count Obamacare taxes in the baseline, assuming that they will be repealed as part of the GOP’s health care agenda, which was released on Wednesday. Those tax add up to close to $1 trillion in revenue over 10 years, a significant amount. It’s not clear whether other tax increases in the House GOP’s health care plan—notably from capping the tax break for employer-sponsored health insurance—would offset the lost revenue from repealing the Obamacare taxes. But the GOP tax proposal suggests otherwise, saying that that the taxes “should be paid for by repealing the massive new entitlement program created by Obamacare.” If that’s true, then the plan includes a hidden drop in tax revenues approaching $1 trillion over 10 years.

House Republicans also count a new pot of one-time money towards the baseline. It comes from taxing the more than $2 trillion that U.S. companies currently hold overseas; Kyle Pomerleau of the Tax Foundation estimates the lost revenue at $200 billion at most. In other words, the plan pays for a permanent $200 billion tax cut with an influx of one-time revenue.

Finally, Republicans also use a “dynamic scoring” model to make the numbers add up: in other words, they assume the plan will trigger growth, which brings in more money. This isn’t necessarily a gimmick, but it’s also a black box: the report doesn’t say how much additional revenue the plan raises through dynamic scoring or even how much growth they expect it to trigger. But it’s possible that the House GOP is assuming their tax plan will bring in unrealistic levels of additional revenue, and magically make its numbers add up.