LPA Foundation
Advisor Veronique de Rugy

Advisor Veronique de Rugy — LPA Foundation

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One thing all GOP candidates agree on: Bold tax reform is needed

January 11, 2016

I am sure if I tell you that this election season has been different than many others, you may think I am talking about the impact Donald Trump’s campaign is having on the current landscape. But that’s not what I am thinking about.

This election year, unlike any other in recent memory, every Republican candidate has been promoting some sort of bold tax reform plan. While each proposal is different, they share common characteristics. They would cut income tax rates on households, lower the tax code's bias against savings and investment, close some loopholes, and reform America's anti-competitive corporate income tax system.

In other words, most plans on the Republican side have been promoting the four important principles of free-market taxation. Here they are:

  • Simplicity: The complexity of the current tax system makes it difficult and costly to comply with and encourages tax avoidance. A simpler and more transparent tax code promotes compliance and increased revenues.
  • Efficiency. The current tax code impedes economic growth by distorting market decisions in areas such as work, saving, investment and job creation. An efficient tax system provides sufficient revenue to fund the government’s essential services with minimal distortion of market behavior.
  • Predictability. Tax certainty inspires economic growth and investment and also enhances competitiveness. An environment conducive to growth requires a tax code that provides both near- and long-term predictability.
  • Fairness: A basic feature of our tax code should be that people with roughly the same income pay roughly the same amount of taxes. Unfortunately, the amount of taxes Americans pay today has little to do with how much money they make and more to do with how many kids they have, whether they rent or own a house, which state they live in, and whether they make their money in the form of wages or capital gains. This system is not only unfair; it is also highly inefficient, as the disparities encourage taxpayers to shift their income and investment around to reduce their tax burden.

What does a tax system along these lines look like? A brief summary would be a low tax rate designed to minimize the penalty of work, entrepreneurship, and productive behavior; no double taxation of saving and investment; and no distortive loopholes for favored activities or consumption.

Well, last week retired neurosurgeon Ben Carson actually proposed such a tax. His plan is a pure version of a flat-tax plan first proposed by economists Robert Hall and Alvin Rabushka. Here are some of the Carson plan’s most important features:

  • A 14.9 percent flat tax on income, which would only apply to taxpayer earnings above 150 percent of the poverty line
  • The implementation of a “de minimis” payment each year so all Americans will be treated as “citizen-owners”
  • The end of taxes on capital gains and dividends
  • The end of all deductions, tax shelters and loopholes, including some of taxpayers’ favorites like the mortgage interest deduction, the state and local tax deduction, and the charitable deduction
  • A repeal of depreciation rules, replaced by full expensing of capital investments.
  • A repeal of the Alternative Minimum Tax

On top of being pro-growth and boosting competitiveness and more, it beats most other candidates’ plans in that it is honest about the fact that middle-class voters will lose their favorite tax deductions. Thankfully, his plan also includes the necessary reforms so that there is no double taxation on savings and investments, which are currently alleviated by exemptions like the reduced rates applied to capital gains and dividends. It is worth noting that Florida Sen. Marco Rubio’s tax plan would also eliminate the capital gains tax, the double tax on dividends, and the second layer of tax on interest, while the plan proposed by businessman Trump wouldn’t at all.

He also takes a step to address the fact that over 45 percent of American households do not pay any federal income tax. That’s radically different from the former Florida Gov. Jeb Bush’s plan that doubles the standard deduction and the Earned Income Tax Credit (EITC), excluding millions from the tax rolls, or Trump’s plan, which would “reduce taxes to zero for 31 million households that currently pay at least some income tax.”

Also, it doesn’t include a giant child tax credit which is paid for by a timid reduction in the top marginal tax rate (Rubio’s plan). It doesn’t continue to cater to many special interest groups (all other plans).

Finally, it doesn’t include a Value-Added-Tax (VAT), which increases our risk of the U.S. becoming like France in having both a VAT and an income tax (Kentucky Sen. Rand Paul and Texas Sen. Ted Cruz’s plans).

This is great news. As Cato Institute’s Chris Edwards wrote a few weeks ago for National Review:

 Senators Ted Cruz and Rand Paul are strong advocates of limited government. … That is why their embrace of the value-added tax (VAT) in their presidential campaigns is so baffling. VATs are the revenue engine of big-government welfare states, not a proper funding source for the small federal government that both senators favor for America. … [T]he candidates hide behind innocuous names — “business flat tax” for Cruz and “business transfer tax” for Paul…

The tab for taxes collected from businesses is ultimately passed through to individuals in the form of lower wages, reduced dividends, or higher prices. … VATs have huge bases. That’s because — unlike income taxes — they do not allow businesses to deduct employee compensation when calculating the taxable amount. … The result would be that tax revenues from businesses under the Cruz and Paul VATs would be enormous….

Because Cruz and Paul shift much of the collection to businesses, more of the tax burden gets hidden from citizens and voters. … If the government is going to take our money, it should mug us on the street in broad daylight, rather than sneak into our homes at night and burglarize us unnoticed. The VAT would encourage more burglary.

For these reasons and more, adopting a VAT would be a big mistake for advocates of limited government.

Now, the Carson plan isn’t revenue neutral, as this score from the Tax Foundation shows. None of the other plans is either. I like that. Contrary to what you hear, that's a good thing, because it means they would reduce the amount of money the government collects from us.

That being said, I have a warning for Carson. While starving the government beast may sound great, enacting a very large tax cut in a fiscal environment of large deficits would be irresponsible. The only sensible approach — both politically and economically — then is to propose serious spending restraint alongside that great tax plan.

To conclude, most of the Republican candidates have proposed plans that would move us closer to an ideal tax system (a low rate, no double taxation of saving and investment and no distorting loopholes). However, in that category, a pure flat tax is the gold standard. As such, I have to conclude that Carson’s tax plan is the best of all the candidates’ plans so far.