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Why Tax Reform Is Needed Now More Than Ever

Tax reform time is here.

During every presidency, there comes a time when the president demands Congress overhaul the tax system, making it easier for normal Americans to pay their taxes each year. President Trump put tax reform on the top of his agenda this year, and congressional Republicans have obliged, releasing a brand new tax reform framework. The framework isn’t perfect, but it’s far better than keeping the current system in place. Republicans should work to pass the reform measure as soon as possible.

There’s just one hitch: Shepherding tax reform through Congress is no easy task. To help get the job done, President Trump should look at previous instances of successful tax reform.

The last time we had any kind of sweeping tax reform legislation, it was during the Ronald Reagan Administration. Many of our younger readers weren’t alive at the time Reagan signed the tax overhaul bill into law.

Given that Donald Trump is a Republican, you can expect to see him face the same kind of criticism Reagan encountered while pushing for massive tax cuts in exchange for eliminating loopholes. Any tax cuts will be portrayed as benefiting “the rich,” and there will be some truth to the claim. After all, if everyone in America was given a 10 percent tax cut, it would be the wealthiest who disproportionately benefit in terms of dollars saved, even though everyone is saving the same percentage. You can also expect to hear the usual talking point that Republicans are practicing “trickle down economics” – a school of economics that no economist has ever claimed to be part of.

To say that cutting taxes boosts economic growth, and that growth benefits everyone, is not to argue that wealth will “trickle down” to everyone else. A better analogy would be to say that a rising tide lifts all boats – something that John F. Kennedy acknowledged when he proposed tax reform in the 60s.

Kennedy did manage to cut the top income tax rate from an astronomical 90+ percent down to 70 percent, and while rates were still outrageously high, the amount of income a top-earner could bring home tripled. Not only that, but there was less incentive to hide gains in tax shelters. As a result, the economy boomed – and tax revenues grew because of, not in spite of, those tax cuts.

Note that the top tax rate applied to a much higher level of income back then. An individual would need to make over $3 million in today’s dollars to be paying that 90 percent rate.

It was the same deal with Reagan. Liberals want you to believe the Gipper wanted wealth to “trickle down” to everyone. But in reality, it poured down.

Reagan presided over two sweeping pieces of tax legislation that reduced the top tax rate from 70 percent in 1980 to 28 percent by 1988. In the case of Reagan, his cuts acted as an economic stimulus, as they came during a recession he inherited. Despite being portrayed at the time as a giveaway to the rich, the share of income taxes paid by the top 10 percent of earners increased, from 48 percent in 1981 to 57.2 percent in 1988.

Reagan also cut the number of tax brackets, reducing them to just two by 1986. The percent of income a middle class family paid in federal income tax was a mere fifteen percent.

And the results speak for themselves. Before considering any criticisms of the Reagan tax cuts, specifically that they led to a boost in the deficit, let’s look at the facts. You can decide if the Reagan’s tax reform trade-offs were worth it by asking these questions via the Heritage Foundation:

  • Would you trade 2.8 million jobs? Before the Reagan tax relief, the unemployment rate averaged 7.7 percent. Since the tax cuts, it has averaged 5.8 percent — a difference that translates into 2.8 million jobs per year.
  • Would you trade $15,000 of your annual income? In the two decades before the Reagan tax relief, the average household’s annual disposable income increased $13,000. In the 20 years following Reagan’s tax cuts, these incomes surged $28,000.
  • Would you trade the stock market boom? In the two decades before the Reagan tax relief, the S&P 500 increased 120 percent. In the 20 years following Reagan’s tax cuts, the market jumped 575 percent.
  • And don’t forget the 12 percent inflation rate and 21 percent interest rates that Reaganomics slew.

When faced with recession, the economy rebounded quickly, growing at a pace double that of the growth seen during the Obama Administration:

Now, the biggest criticism of the Reagan tax cuts you’ll hear is that despite any economic benefits they may have provided in the short term, the cuts exploded the national debt. And on face value, that criticism appears to be valid. During the Reagan years, $1.86 trillion was added to the national debt, a 186 percent increase from the $998 billion debt that was accumulated by the end of Jimmy Carter’s last budget.

But don’t blame the tax cuts for that. Reagan spent $3 trillion on defense while in office due to the Cold War. If the defense budget had increased by its baseline, “only” $2.2 trillion would’ve been spent. That accounts for $800 billion, or half of the national debt increase overall. You can blame spending increases as a result of the Democrat-controlled Congress during the Reagan years for the rest. Revenue didn’t decline under Reagan, spending just increased at a faster rate.

Those were the results of tax reform in the 1980s – and we’ve come a long way since then. Starting with Mr. “read my lips, no new taxes” George H.W. Bush, tax rates leaped upward. Even after the tax cuts enacted under George W. Bush, rates were still much higher than during the Reagan years. The number of brackets has increased, the rates have increased, and the real (inflation-adjusted) dollar value that higher rates apply to has fallen.

So that brings us to today. Let’s first summarize the Trump tax plan as per the Senate’s blueprint, then look at what could be improved upon.

  • Tax brackets will be consolidated from seven to three. The lowest tax bracket will increase from 10% to 12%, but this will NOT translate into a tax increase, because the standard deduction will be doubled, which will reduce the amount of income subject to that tax rate in the first place.

However, one massive flaw in the Republican tax plan is that it also wipes out personal exemptions. Without personal exemptions removed, lower earners would save a heck of a lot more money. Below you can see the effects of a doubling of the standard deduction, while allowing low income earners to keep other deductions in place.

Given the relatively small percent of all taxes that lower income earners pay as is, it makes no sense to eliminate their deductions. One rich person’s deductions are going to equal the deductions of a thousand middle-class earners. So, if we want to keep things fair, deductions, write-offs, and loopholes used by the rich should be targeted. Alternatively, it could also make sense for the government to just eliminate the bottom tax bracket of 10 percent entirely. Low-income individuals are just going to get that money back during tax season, so why make them essentially loan the government their money for free in the meantime?

Here are more details from the proposed GOP plan:

  • The middle tax bracket will be 25 percent, and the top bracket will be reduced from 39.6 percent to 35 percent (back to where it was following the Bush tax cuts). It’s unclear what levels of income these will yet apply to.
  • Deductions for mortgage interest, charitable giving, and retirement (401ks, IRAs) are kept.
  • Those with “non-minor” dependents (such as grandparents who live with them) will receive a $500 tax credit per dependent
  • Small business top tax rate will be capped at 25 percent, while the corporate tax rate will fall from 35 percent (among the highest in the world) to 20 percent.

There certainly is room for improvement. As mentioned before, much of the benefits from doubling the standard deduction are counteracted by removing personal exemptions. A single person earning $25,000 a year would only end up saving just under $200 with President Trump’s tax plan. With personal exemptions left in, if we’re to assume a 25 percent tax rate, then there would be an additional $1012 annually (25 percent multiplied by $4,050 in personal exemptions), for roughly $1300 in total savings.

It’s an incredibly easy fix to make, too. Just double the standard deduction – and do nothing else.

With that small change, President Trump’s tax plan would be nearly perfect. But even without it, the current plan would be vastly preferred compared to the status quo. Historically, if left unchecked, taxes only go in one direction: up.

It’s time to end the current trend of ever-increasing taxes. Republicans need to pass tax reform now, and bring relief to hard-working American families!



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