The Senate’s Tax Advance
The Senate was poised to pass its version of tax reform as we went to press Friday evening, with likely 51 of 52 Republicans in favor but no Democrats. The last few days of vote-buying weren’t pretty, but the big picture is that reform has taken a giant step forward.
The bill won’t include Bob Corker’s proposed “trigger” that would have revoked some of the tax cuts if revenues failed to materialize as estimated by Congress’s budget gnomes. The original mechanism ran into procedural trouble under Senate budget rules, and the GOP decided not to write a tax increase into the bill. This is good sense given that no one knows what the economy will look like in six years.
But Senate leaders did have to mollify Ron Johnson (Wisconsin) and Steve Daines (Montana), who demanded a bigger tax break for “pass through” businesses that may now have an advantage over corporate competitors, which are taxed on income and dividends. The duo were offered a 20% business-income deduction (up from 17.4%) but held out for 23% for a small group of large companies.
Jeff Flake of Arizona insisted on one pointless change, though to his credit he is voting for a bill that will benefit the country despite his differences with President Trump. The Senate and House bills allow for immediate expensing on new investments for businesses for five years, and the assumption is this will be extended. Mr. Flake thinks this is false deficit advertising, and so his change would phase out expensing over time. That won’t bind a future Congress, and in the meantime Mr. Flake ate up billions that had to be paid for by worse policy elsewhere.
By the way, Democrats are flogging a Joint Committee on Taxation report this week that the tax bill will increase the deficit even on a “dynamic” basis that considers how individuals will respond to incentives. But the real news is that even Joint Tax says the bill is pro-growth, adding 0.8% to the economy, which is miraculous given its historic biases. Joint Tax models posit a relatively closed U.S. economy rather than an open global capital market that could finance U.S. deficits.
Some Senators in their self-regard will now want the House to accept their product whole, but there should be a conference committee to blend the best of both bills. The Senate’s “base-erosion” rules that prevent corporate tax dodging are better, but the House bill’s cap on the mortgage-interest deduction and elimination of other carve-outs deserve inclusion. Ditto the repeal of the death tax.
We can also dare to hope that a conference will fix the bill’s biggest flaw, which is a lousy individual tax reform that raises taxes on many Americans in high-tax states. Eliminating the state-and-local income tax deduction, as both bills do, is sound policy. But the bills don’t offset that with a corresponding reduction in the top marginal tax rate. This means many productive people will soon face marginal rates well above 50% in New York and California.
The Senate bill merely reduces the top rate to 38.5% from 39.6%, and the House even raises it with a bubble bracket of 45.6% on some earners. The great irony is that the GOP is raising taxes on some of its most loyal voters if individual rates stay as they are.
A conference committee needn’t take long given that the two bills share a basic structure and the core virtue of a 20% corporate tax rate. But the details deserve scrutiny, and making the bill as pro-growth as possible is worth the extra political lift.
Appeared in the December 2, 2017, print edition.