The House Republican tax plan unveiled on Thursday reflects the party's orthodoxy that tax cuts are boons for the economy -- a credo that has been embedded in the GOP psyche since Ronald Reagan's presidency.
But although Republican leaders often invoke Reagan and credit his tax cuts with touching off the 1980s' economic surge, the record is more mixed. Checking out this history is instructive.
Certainly, the stakes are large for President Donald Trump and the Republican congressional leadership, who are under pressure to deliver on a big campaign promise, after failing to "repeal and replace" Obamacare. The authors of the House plan tout it as a tax cut that will primarily benefit the middle class and rev up the economy, creating jobs.
"I feel like we just played the World Series of Tax Reform and the American people won," House Ways and Means Committee Chairman Kevin Brady said, quoting Reagan when signing the 1980s' tax legislation. Reagan lowered taxes drastically in 1981 and did so again in 1986.
As the bill-writing process grinds forward, Republican lawmakers should keep in mind three lessons from the Reagan era:
Tax cuts result in big deficits and national debt run-ups
Two forces are in longstanding contention among Republicans -- disdain for budget deficits and zeal for tax cutting. For a long while, the theory of economist Arthur Laffer managed to bridge that gap by contending that lower taxes led to more economic activity, which in turn expanded federal revenue. Experience, though, has muted this argument. The national debt during the Reagan administration almost tripled.
By Representative Brady's admission, the House bill costs $1.5 trillion over 10 years, although other estimates place the tab far higher. As the Committee for a Responsible Federal Budget noted, the recently passed House budget blueprint called for a revenue-neutral tax bill and $200 billion in spending cuts -- an unlikely scenario.
The Federal Reserve Bank of St. Louis calculates that the deficit now tops US GDP, up from two-thirds of GDP 10 years ago. The House plan likely will push it way higher.
Tax plans tend to favor the wealthy
Standard political rhetoric always garlands any tax plan as being a big help to the middle class and less-fortunate citizens. The new House plan is no exception. Indeed, its proponents make much of keeping the top individual tax rate at 39.6 percent.
To be sure, the Reagan cuts were proportional, so those on the lower end of the income curve indeed benefited. But one could argue that the better-off still came out ahead, with the top rate dropping to 50 percent from 70 percent due to the 1981 bill, and to 25 percent in the 1986 one.
Meanwhile, payroll taxes for Social Security and Medicare rose, which most affected the less well-paid as income growth of wealthier Americans increased and that for people of modest means dropped.
The House plan does help lower-income people by almost doubling the standard deduction. Married filers, for instance, would get $24,000, up from the current $12,700. Trouble is, it also axes the personal exemption ($4,050), which takes some of the shine off this benefit. The bill also eliminates the 10 percent bracket and starts taxing at 12 percent. On the high end, the threshold for that top 39.6 percent rate moves up to $1 million from $470,000 for married filers.
Other provisions are tilted to the wealthier end of the spectrum. For instance, the plan abolishes the alternative minimum tax, which captures mostly higher-income taxpayers. And the measure establishes a 25 percent rate for "pass-through income," which is meant for partnerships. While that includes small businesses, it also ropes in hedge funds, real estate partnerships and other high-end enterprises, that now mostly pay higher rates on this income.
According to the liberal Economic Policy Institute, 49 percent of pass-through income goes to the top 1 percent of households. Also, the estate tax, paid by the rich, phases out in 2024 and in the interim almost doubles the exemption to $10 million.
Unintended consequences can result
Mr. Trump once attacked the 1986 tax reform for causing the real estate crunch of the early 1990s, which almost took his empire under and sparked the savings and loan crisis, during which many thrift institutions had to be shuttered. His ire was directed at the law's squeeze on well-heeled tax dodgers who invested in property partnerships, many of which were designed to lose money, with the resulting paper losses written off against other income.
Although many factors caused that era's real estate debacle and S&L rout, such as loose lending standards, the end of the "passive-loss" tax dodge contributed. As Linda Postorivo, chief investment officer of Beringer Group asset managers, wrote: "Once the tax advantages disappeared, so did the funding of investments because passive investors had provided much of it. The domino effect caused an implosion in the real estate market."
Tax legislation is an enormously complex endeavor, rivaling a Rubik's Cube. But it would pay to look at what happened in the Reagan era before launching forth into this choppy sea.
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