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How low could Congress cut tax rates without losing revenue? To put it another way, could President Trump and the House Republican leadership fully fund the sorts of individual and corporate tax rate cuts they have been promoting by eliminating current tax preferences?
To find out, the Tax Policy Center ran three experiments: What would happen if Congress wiped out nearly every business and individual tax expenditure –more than 200 of them, by the Joint Committee on Taxation’s count? What would happen if it preserved three important preferences for low- and moderate-income households but repealed the others? Finally, what would happen to tax rates if Congress created a reform plan that not only raised about the same amount of revenue as the current law but also distributed the tax burden in roughly the same way?
Eliminating all tax breaks
TPC found that if Congress eliminated nearly all tax preferences, it could set rates of 6.1/11/28 percent for individuals and 26 percent for corporations without reducing overall revenues. These would be significant rate cuts compared to the current code, where individual rates range from 10 percent to 39.6 percent and the top corporate rate is 35 percent. TPC calculated the rates for 2018, but aimed for revenue neutrality in 2037. That seems far off but was necessary to reflect the long-run deficit effects of the changes.
But here is the rub: To get rates down to the levels TPC calculated, Congress would have to end every single individual tax expenditure and nearly every business tax preference. On the individual side, that means repealing the Alternative Minimum Tax and popular deductions for mortgage interest, charitable giving, and state and local taxes. Lawmakers would have to end the tax exclusion for employer-sponsored health insurance and state and local bonds, and repeal refundable credits for low- and moderate-income households such as the Earned Income Tax Credit (EITC) and the Child Tax Credit (CTC). Investment income would be taxed like wages at ordinary tax rates.
Business preferences on the block
For business, preferences such as subsidies for research, alternative and fossil fuel energy production, and domestic manufacturing would all be on the block. Because the TPC analysis created a territorial tax system, it did not repeal the tax preference that allows US-based multinationals to defer US tax on some foreign-source income.
To the degree Congress preserves any tax preferences, it would have to either scale back those rate cuts or reduce revenue at a time when the Congressional Budget Office projects the federal budget deficit will rise to 5.2 percent of GDP by 2027.
That leads to two inevitable conclusions: 1) It is theoretically possible—but highly improbable—that Congress could get individual rates down to Trump-like levels without adding significantly to the federal debt. 2) When it comes to corporate taxes, the story is much worse. In a revenue-neutral bill, Congress can’t get the rate below 26 percent even if it eliminates nearly every corporate tax expenditure. Trump’s 15 percent goal or even the 20 percent favored by the House GOP leadership is a pipe dream. It will be an enormous challenge for Congress to cut the rate below even 30 percent without losing a large amount of tax revenue.
There are only two other possible outcomes: Congress could try to find some other source of tax revenue, such as a value-added tax or a carbon tax, or bar firms from deducting ordinary business expenses such as interest or wages. Or it could rely on implausibly high economic growth rates to generate the needed revenue, at least on paper.
In the second test, TPC looked at what would happen to rates if Congress protects three important tax preferences for low-income households--the EITC, the CTC, and the partial exclusion of Social Security benefits from income taxation. With those changes, Congress could bring roughly revenue-neutral individual tax rates down a bit less--to 6.4/11.5/29.3 percent. The corporate rate could again fall to 26 percent.
Finally, TPC tried to design a plan that met all three goals: It had to be revenue-neutral, preserve the three tax preferences for low-income households, and be roughly as progressive as the current system.
You can’t get there from here
It turned out to be impossible to achieve all three with a three-rate individual income tax system. So TPC had to create a four-rate structure: a zero percent rate to replace the current 10 percent bracket, a 5 percent rate for those in today’s 15 percent bracket, a 16 percent rate in lieu of the current 25 and 28 percent rates, and a 29.9 percent bracket for those in the 33, 35, and 39.6 brackets.
TPC effectively worked backwards from the way the upcoming tax bill is promoted by its advocates. Trump and the House GOP leaders start with rate cuts that they promise to offset (at least in part) with reductions in unidentified tax preferences. TPC started by identifying and ending the preferences, then calculating how much of a rate cut Congress could buy with those changes in a revenue-neutral bill.
Gazing through TPC’s end of the looking glass makes the picture clear: Trump and Congress can’t get there from here. They’ll have to either sharply scale back their ambitious tax rate reduction goals, find some new revenue source (such as a consumption tax), or significantly reduce federal revenue.
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