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The Reality of Tax Reform Math

“Eliminating all tax preferences would allow for a top individual rate as low as 23 percent and a corporate rate of about 27 percent without increasing the deficit,” a new memo from the “Fix the Debt” campaign states.  The memo presents these rates as a starting point for tax reform, noting that policymakers will want to restore certain tax preferences (which would result in higher rates).  These extremely low tax-rate figures could, however, help strengthen a mistaken impression that tax reform will be able to lower tax rates dramatically without swelling the deficit.

Achieving very large savings by eliminating major expenditures is extremely difficult politically.  The biggest tax expenditures, such as the mortgage interest and charitable deductions and the tax-exempt treatment of employer-provided health care, are very popular.  And even small cuts in tax rates are extremely expensive.

For example, one proposal on the table is the President’s proposal to cap, at 28 cents on the dollar, the tax subsidy that affluent Americans receive for tax deductions and some other tax expenditures.  The proposal, which would raise about $500 billion over ten years, is relatively modest in the sense that it would target people in tax brackets above the 28 percent bracket and would scale back rather than eliminate the affected tax subsidies.  Even so, the proposal goes much too far for many policymakers, and it has run into strenuous opposition from a powerful array of interests.

Yet cutting marginal income tax rates by just two percentage points across the board, which would lower the top rate to 37.6 percent, would cost about three times as much as the Obama proposal:  about $1.5 trillion over ten years, based on estimates from the Urban-Brookings Tax Policy Center.  Cutting the top rate all the way to 23 percent, the figure in the “Fix the Debt” memo, would cost many trillions more.  And these costs don’t take into account that some of the savings need to go for deficit reduction, as the memo itself calls for.

The Congressional Research Service (CRS) also has cautioned against counting on big tax expenditure savings.  CRS has written:

[T]here are impediments to . . . eliminating or reducing tax expenditures, because they are viewed as serving an important purpose, are important for distributional reasons, are technically difficult to change, or are broadly used by the public and quite popular. Given the barriers to eliminating or reducing most tax expenditures, it may prove difficult to gain more than $100 billion to $150 billion in additional tax revenues [in 2014] through base broadening.

Savings of this magnitude, CRS explains, “would not allow for significant reductions in tax rates”; they would offset the cost of only “about a one or two percentage point reduction.”

The basic math of tax reform, as outlined here, isn’t well enough understood.  But if tax reform is going to be fiscally responsible, policymakers are going to have to learn it.

Chuck Marr
Vicepresidente de Política Tributaria Federal