Can the GOP Get Tax Reform Right?

Congressman Kevin Brady, Chairman of the House Ways and Means committee.

After the failure of the GOP to get a repeal of Obamacare passed, Americans must consider whether or not the party can complete other parts of its agenda. Foremost among those parts is the tax reform proposal. The Wall Street Journal’s editorial board zeros in on six principles that would make the reform plan “pro-growth.” These are:

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• The growth priority. After 12 years of a lackluster economy, or worse, tax reform’s overriding goal should be to lift annual GDP to 3% or more. The current expansion is into its ninth year and showing signs of age. Europe has grown faster than the U.S. for some time. The Trump bump in financial markets hasn’t been matched in the real economy.

Amid a labor shortage and sluggish incomes, a capital spending surge is crucial to give the expansion a second wind. This is where tax reform must focus. This means lowering tax rates on business and individuals to spur risk-taking and investment.

In particular it means cutting the U.S. corporate tax rate low enough to compete with the rest of the world and return $2 trillion in capital that U.S. companies have stashed overseas. A corporate rate much higher than 20% won’t do the job. The evidence of economic research is overwhelming that cuts in corporate tax rates flow to workers in higher wages.

The political opposition will come from Democrats and many Republicans who view tax reform mainly as a populist lever to redistribute income. They include White House aide Steve Bannon, who wants to raise tax rates on the affluent, and conservatives like Mike Lee on Capitol Hill who think taxes should serve social policy. The risk is that they will steal money for tax credits that do nothing for growth and could be used to reduce rates.

• Make cuts immediate. One temptation in every reform debate is to phase-in tax cuts to fit inside Congress’s 10-year budget-deficit box. That is a growth killer as investors delay decisions to wait for lower rates. George W. Bush made that mistake with his 2001 tax cut, which was a growth bust. He corrected it by making his 2003 cuts immediate, and the faster growth that followed saved his re-election.

• Permanence. Businesses invest with a long tail, and they will scuttle some projects if they think lower rates go poof after five or 10 years. Mr. Bush made this mistake in 2003 and Barack Obama took advantage in 2013.

Thursday’s joint GOP statement says the goal “places a priority on permanence,” which is progress. Some provisions, such as business expensing, could end after five years without doing too much harm. But tax rates should be fixed in law so future Congresses will have a harder time changing them.

• Reform, not merely a tax cut. One reason tax reform spurs growth is by reducing subsidies so capital can flow where it gets the highest return. This efficiency increases productivity, which increases wages. But this means stripping out as much chaff as possible in the tax code like subsidies for electric cars, real estate or racetracks.

Ending these subsidies also helps pay for lower rates. But the GOP has already agreed not to change the mortgage-interest or charitable deductions, and now the trillion-dollar BAT is dead. Reformers will have to fight that much harder to end the big-dollar deductions for state and local taxes and for interest on business borrowing.

If that becomes too difficult, the temptation will be to abandon reform and default to the lowest-common political denominator of a simple tax cut. This would be better than nothing, but it won’t boost capital investment or the economy nearly as much in the medium- or long-run.

• The deficit-neutral trap. The budget outline now moving through the House promises a balanced budget in 10 years including tax reform. That may be necessary to pass the outline but it could be the death of tax reform if it locks the GOP into the fiscal prison of budget “scores” by the Congressional Budget Office and Joint Tax Committee.

Speaker Ryan has worked for years to get those bureaucracies to better account for rising tax revenues that flow from faster growth, but they still use models that underestimate the growth impact of tax cuts on capital and marginal rates.

Rep. Kevin Brady talks tax reform

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E.J. Smith - Your Survival Guy

E.J. Smith is Founder of YourSurvivalGuy.com, Managing Director at Richard C. Young & Co., Ltd., a Managing Editor of Richardcyoung.com, and Editor-in-Chief of Youngresearch.com. His focus at all times is on preparing clients and readers for “Times Like These.” E.J. graduated from Babson College in Wellesley, Massachusetts, with a B.S. in finance and investments. In 1995, E.J. began his investment career at Fidelity Investments in Boston before joining Richard C. Young & Co., Ltd. in 1998. E.J. has trained at Sig Sauer Academy in Epping, NH. His first drum set was a 5-piece Slingerland with Zildjians. He grew-up worshiping Neil Peart (RIP) of the band Rush, and loves the song Tom Sawyer—the name of his family’s boat, a Grady-White Canyon 306. He grew up in Mattapoisett, MA, an idyllic small town on the water near Cape Cod. He spends time in Newport, RI and Bartlett, NH—both as far away from Wall Street as one could mentally get. The Newport office is on a quiet, tree lined street not far from the harbor and the log cabin in Bartlett, NH, the “Live Free or Die” state, sits on the edge of the White Mountain National Forest. He enjoys spending time in Key West (RIP JB) and Paris. Please get in touch with E.J. at ejsmith@yoursurvivalguy.com To sign up for my free monthly Survive & Thrive letter, click here.