House tax bill promising but needs improvements

Last week, House Ways and Means Committee chairman Kevin Brady (R-Texas) introduced a detailed tax reform bill. The bill’s centerpiece is a long overdue reduction in the headline corporate income tax rate from 35 to 20 percent, a welcome step to promote long-run economic growth.

The bill also addresses numerous complications and distortions in the individual income tax. But the bill has a downside: It would add to the federal debt, pushing costs onto future Americans and possibly paving the way for future tax increases that could undo the bill’s achievements.

{mosads}Slashing the headline corporate tax rate, the highest in the developed world, would dramatically lower the tax penalty on chartering companies in the United States and booking profits here. More important, the rate cut would lower the tax penalty on placing factories, equipment and other investments in the United States.

Bringing extra capital to our shores would make American workers more productive, driving up their wages. The Tax Foundation recently estimated that the bill would boost wages by 3.1 percent over the upcoming years — an eventual gain of $1,550 for a worker earning $50,000.

The actual wage gain would probably be somewhat smaller because the Tax Foundation’s analysis did not account for the higher interest rates that the bill would likely produce. But uncertainty about the size of the gain should not obscure the rate cut’s benefits to workers.

The bill would also curb interest expense deductions for companies with high debt loads, a sensible way to narrow the corporate tax’s bias in favor of debt. On the other hand, the bill’s new special tax rate for non-corporate business income would add complexity and create opportunities for tax gamesmanship.

Another poorly crafted provision would allow businesses to claim immediate up-front deductions for the costs of equipment investments made through 2022. The provision would distort investment decisions by artificially favoring equipment over buildings and inventories, which would not receive the tax break. Even worse, this temporary incentive would do nothing to boost long-run growth.

The bill makes numerous improvements to the individual tax code. A larger standard deduction, combined with cutbacks in itemized deductions, would prompt millions of Americans to simplify their tax filing by switching to the standard deduction.

Scrapping the alternative minimum tax would provide further simplification. The bill would also eliminate the deduction for state and local income taxes, along with a host of smaller tax breaks.

The bill strikes a blow for good tax policy by lowering the limit on tax-favored mortgages and capping deductions for state and local property taxes. These changes would trim the tax codes’ misdirected subsidy for large, expensive houses without hindering anyone from attaining the dream of homeownership.

Unfortunately, the bill would not reform the largest individual income tax break, the favorable treatment of employer-provided health insurance.

The bill’s biggest drawback is that, over the next decade, it would add more than a trillion dollars to the federal debt, which is already large and growing. The extra borrowing raises three major concerns.

First, the borrowing might drive up interest rates, which would reduce investment. Second, under Senate rules, the bill’s increased deficits cannot continue beyond the next 10 years. To comply with those rules, the Senate may ultimately amend the bill to have the corporate rate cut expire after 10 years.

A temporary corporate rate cut would do nothing to boost long-run growth. In some cases, it could even reduce investment while it was in effect.

Third, the extra debt would need to be serviced through future tax increases and spending cuts, which could undermine the bill’s pro-growth objectives. The bill seeks to reduce business tax burdens and promote investment, but those gains would be undone if a future Congress and president ultimately raise business taxes to service the debt that the bill would leave in its wake.

Of course, the business tax reduction could be preserved if future policymakers were to raise taxes on middle-class households or cut their benefits. If that’s the plan, though, why does the bill offer middle-class tax cuts today?

We need to cut the corporate tax rate, but the cut should be permanent and budget-neutral. The revenue loss from the rate cut could be offset by raising taxes on shareholders’ dividends and capital gains, scaling back the bill’s individual income tax rate reductions and by curbing the tax break for employer-provided health insurance.

The House bill holds promise, but improvements are needed. 

Alan D. Viard is a resident scholar at the American Enterprise Institute.