tax reforms

Henry Hazlet in his classic book, Economics in One Easy Lesson, noted that key to understanding economics is not just look at who benefits today from an anticipated economic policy but the long run.  It has been said that in the long run, we are all dead but it doesn’t mean that one can’t review policy as long term efforts.

Hazlet noted in that while one can’t ignore those effected today, it equally bad to ignore those that politicians can’t see being effected.  There are winner and losers in many tax debates but the good news is that economic is not zero sum. Tax codes are often used as means to pick winner and losers as it is about raising revenues.  Both Republicans and Democrats have used the tax codes to favor their constituents and any reforms of the tax codes does affect those constituents favored by the code and their politicians. 

The good news is that there is a new paradigm when it comes to tax reforms with even Obama own deficit commission repudiating Obamanomics in favor of a liberal version of Reaganomics which explains why Obama doesn’t refer to his own commission for solutions. It is tough for those on the left when a moderate Republican and a liberal Democrat led commission essentially states that the Obama war on the rich is stupid economics.  There are times that good politics produces bad policies and Obama politics of envy is bad policy. 

So the good news is that liberal Ron Wyden, conservative Paul Ryan, liberal Erskine Bowles and moderate Alan Simpson all agree on what makes for tax reform:  lower marginal tax reforms plus the elimination or reduction of deductions. The commission also admitted that present federal spending is way too high and federal government spending should be capped, the basis for a compromise for entitlement reform is being formed.

The first goal of any tax reform is to increase incentives for investments and encourage more efficiency and the second goal is to raise revenues to provide the needed services (note the word, needed as oppose to want.)  For the past four decades, tax revenues often averaged 18-20% of GNP and until the Obama administration, federal spending averaged around 20% of GNP but now Obama has managed to push spending to 25% and federal debt is now over 100%, something we had not seen since World War II.

The deficit commission recommends that spending should be capped at 21% whereas Paul Ryan goal is 18% but the good news is that there is consensus that federal spending should be capped and limited, and there is momentum toward entitlement reform.  When Ron Wyden joined Paul Ryan to reform Medicare, it signal that there is a consensus to reforming the entitlements and with Republican nominees supporting the Wyden-Ryan reforms; it shows that in a Republican administration, reform can be done. 

There are many different reform packages, each with different details including the Perry Plan which reduces marginal tax rates for both business and individual while making changes in the tax code.  There will be no capital tax gain tax plus many common deductions are preserves for those under half a million.  The Perry plan goal is to ensure that the majority of Americans see their common deductions maintained but he eliminates those deductions for those in the upper incomes.  For the wealthy, they will lose deductions for state and local taxes as well as their mortgages exemption reduced or eliminated but capital gain tax and the death taxes eliminated. The Perry plan encourages the wealthy to invest in job creations and not in oversized homes.  Gingrich plan is similar and both the Gingrich and the Perry plan highest tax rates are lower than those of the Ryan plan and the deficit plan.  The deficit plan anticipate raise revenues higher than other plans as they eliminate more of the deductions than other plans.  There is no doubt in the mind of the deficit commission plan that their plan will raise more revenues than the present or other proposed plans.

The Cain plan may have been the most imaginative since it encompasses a broader path to tax reform.  Cain own goal is to switch to a strict national sales tax but his 9-9-9 plan does broaden the tax base as he incudes a sale tax to go with lower business and individual taxes.   Cain plan may capture tax sources that others may miss within the underground economy or at least, it forces everyone to pay some taxes.   Plus he adds a supermajority provision to raise taxes; making it more difficult to Congress to raise taxes, in particular the sales tax.

The national sale tax disadvantage is that even by its proponents, it will be at least 23% and while it eliminates income and other taxes, the average voter will see 23% increase on the purchase of goods.  It is a case that the taxpayer may not appreciate the benefits of the no income tax if he or she is paying 23% increase in a new car.

Cain plan 9% sale tax is less than half of his national sale tax proposal and during the campaign, he did adjust his tax plan to help lower income voters to make it more palatable to voter and reduce the charge that his plan hurts the poor or lower income. 

The grand compromise that is starting to simmer from the underground featuring the following, lowering the marginal tax rates in exchange for reduction or elimination of deductions  thus broadening the tax base.  Cain adds even a third step that broadens the tax base even further.  On top of that, there are serious plans to reform entitlements and cap federal spending; an important supplement to tax reforms for tax reforms combined with capping federal spending will be important in preserving the American dream and the American economy. 

The key to tax and entitlement reforms is to go beyond those who will lose under these plans and understand that greater number will benefit including many of today’s present who stand to lose the most under reform plans with future prosperity and opportunities.