Hoover Daily Report

The GOP Candidates Square Off on Taxes

via Wall Street Journal
Thursday, November 3, 2011

The 2012 election is shaping up as a historic confrontation over the proper size and scope of government spending, taxes, deficits and debt. After three years of the Obama presidency, the Republican presidential candidates are offering voters clear alternatives—especially on taxes.

Their proposals range from modest to bold, and they include lower rates and a broadening of the tax base. They stop the scheduled expiration in 2013 of the Bush-era tax rates, and ObamaCare's tax increases. Some reduce taxes substantially. Most abolish the estate tax. They support a balanced budget amendment, spending caps and specific spending controls, e.g., Rick Perry, a higher retirement age; Newt Gingrich, many structural reforms; Mitt Romney, block-granting Medicaid.

By contrast, President Obama proposes ever more deficits and debt, spending and taxes, especially higher taxes on the "rich" to pay their "fair share." Yet the U.S. already has the most progressive tax system in the 34-member Organization for Economic Cooperation and Development. The top 1% of taxpayers, with 20% of income, pay 38% of income taxes, whereas 51% of Americans pay none. The U.S. has the second-highest corporate income tax rate (35% federal plus 4% average state) of any advanced economy.

And if we remain on our current spending trajectory, we'll see increases in income and payroll taxes not just on the "rich," but on all taxpayers, eventually driving marginal tax rates over 80% at the top and over 70% on many middle-income working couples. This, clearly, is a recipe for economic disaster.

So, what do the GOP candidates want to do differently?

Mr. Romney proposes to stop the expiration of the Bush tax cuts and the health-care law increases, keeping the top marginal income tax bracket at 35% (not rising to 39.6%) and capital gains and dividend taxes at 15% (not rising to 23.8%), and eliminating the latter taxes altogether for income below $200,000. He would also implement a 25% corporate rate (the OECD average) and eventually eliminate the double taxation of repatriated earnings altogether, upon which taxes have already been paid abroad, switching to what economists call a "territorial" corporate tax. On the fiscal side, he wants to cap spending at 20% of GDP. By no means radical—save perhaps the territorial corporate tax—these proposals are Hippocratic, avoiding the harm from Mr. Obama's tax plans.

Jon Huntsman boldly proposes three income tax rates—8%, 14% and 23%—and the elimination of all deductions and credits. Investors would pay zero tax on capital gains and dividends. The alternative minimum tax would be eliminated. Like Mr. Romney, he's calling for a 25% corporate territorial tax rate with no taxes on repatriated earnings.

Rick Perry proposes an optional 20% flat tax with deductions for mortgage interest, charity and state and local taxes for incomes under $500,000; zero on long-term capital gains and dividends; a personal exemption of $12,500 (a family of four earning $50,000, roughly median income, would pay no income tax); a 20% corporate territorial rate, and a spending cap of 18% of GDP.

Newt Gingrich proposes an optional 15% flat tax rate with a charitable deduction; zeroing out capital gains taxes; keeping the earned-income and child credits; a 12% corporate rate; immediate expensing of all capital investments, and structural reforms to federal agencies from the EPA to the FDA. Making the flat tax optional would lose some of the revenue and simplicity of a pure flat tax, but it would also guarantee that nobody's taxes increase.

Herman Cain proposes a 9% flat tax on income (with a charitable deduction and no tax on long-term capital gains); a 9% retail sales tax; and a 9% tax rate on gross corporate income (including wages) with expensing. The payroll tax is to be abolished. Eventually he wants to replace the income tax with a national retail sales tax. He's vague when it comes to specific spending cuts or caps, including entitlement reform.

Finally, Ron Paul proposes to completely eliminate the income and capital gains taxes, which he would pay for with "massive spending cuts" to the federal budget, including abolishing the IRS, more excise taxes and "nonprotectionist" tariffs. (Michele Bachmann and Rick Santorum have laid out far fewer details than the others, so I have not included them.)

From Mr. Romney's modest reforms to the bolder proposals of Messrs. Huntsman, Perry, Gingrich, Cain and Paul, these are major improvements on current law. Permanent reductions in marginal tax rates, which improve incentives to work, save and invest, have historically been associated not only with higher long-run growth but also immediate strengthening of the economy. (See the growth following the Kennedy tax cuts in 1964, the Reagan cuts in 1983, and the Bush tax cuts in 2003.)

The balanced budget amendment and spending caps are important complements to tax reform. Historically, tax reform and reduction have been easier to accomplish than spending control. But without serious spending control, reforms are doomed to be undone. To date only House Budget Chairman Paul Ryan, who is not a candidate, has laid out a fully consistent fiscal policy including specific ways to control spending.

Attacks on the GOP candidates' plans emphasize their supposed effects on the distribution of income and the size of federal revenues—but the attacks use simple static models. Distribution and revenue are legitimate concerns—we need sufficient revenues to fund the necessary functions of government. But viewed over longer periods, the distributional consequences are partly attenuated. As to revenue, Harvard's Martin Feldstein estimates that over time nearly 40% of the taxes that static analysis said would be lost due to Reagan's 1986 tax cuts (the top marginal rate was lowered to 28%) was recouped from the resulting economic growth and higher taxable income.

The plans raise other concerns. A retail sales tax risks funding an ever-growing government, as has the value-added tax in Europe. Mayors and governors cast a nervous eye at possible federal retail sales or value-added taxes, or ending deductibility of state and local taxes.

Big exemptions can create a majority paying nothing and voting more spending at the expense of a taxpaying minority. Indeed, Milton Friedman, my former colleague and winner of the 1976 Nobel Prize in economics, originally proposed his flat tax to prevent precisely that.

Nevertheless, the future of our fiscal system, so important to the nation's prosperity, may well evolve from one of these plans. If one of these candidates becomes the next president, he would be wise to include the best compatible ideas from each.

Mr. Boskin is a professor of economics at Stanford University and a senior fellow at the Hoover Institution. He chaired the Council of Economic Advisers under President George H.W. Bush.