ANALYSIS/OPINION
Republican Sens. Mike Lee of Utah and Marco Rubio of Florida recently laid out their vision of tax reform. They are right to push for reform. Our burdensome tax code is one of the major obstacles holding the economy back from reaching its potential. In the process, it is denying countless American families the opportunities they deserve.
The purpose of tax reform is to boost the economy by increasing incentives to work, save and invest (i.e., take prudent risks). The best way to achieve this is to reduce marginal tax rates and apply them to a correct tax base.
The senators’ plan is only an outline right now. However, from the details they’ve provided thus far, it appears that they make two mistakes that would prevent their plan from freeing the economy to grow as strongly as it should.
In summary, their plan looks like this: The income tax would retain only two rates, 35 percent and 15 percent, for individuals and families. The authors would also abolish many deductions (but don’t say which ones) and increase the child tax credit from $1,000 per child to $2,500.
Their first mistake is not defining their tax base.
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The question of the base attracts less attention than the rate, but is equally important. It is important because it is the foundation of a plan. Just as with a house, if a plan’s foundation is faulty, it will never function as well as it should.
Our current tax base is a dilapidated mess, as responsible for the tax code’s drag on the economy as are high rates. It is a hybrid between a consumption and income tax. Because it retains many elements of an income tax, it ends up double-taxing investment, which discourages growth.
If Mr. Lee and Mr. Rubio keep the current faulty hybrid approach, it will greatly reduce their plan’s economic benefit. They should establish a consumption base so they don’t tax investments twice.
When people hear the term “consumption tax,” many think of a retail-level sales tax, but that doesn’t have to be the case. The traditional flat tax and a consumed-income flat tax are consumption taxes that are administered like an income tax.
The Lee-Rubio plan is heavily family-centric. That leads to their second mistake. Rather than reduce the top rate substantially below 35 percent, which is only a few percentage points below where it is now, they chose to increase the child tax credit by 150 percent.
Beyond the extra $1,500 per child, families derive no economic benefit from the higher credit. And singles, childless couples and those whose children are grown derive no benefit at all. Families are important, but focusing solely on them and forsaking growth is misguided.
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A consumption tax with a low rate would boost the median family income by approximately $5,000, according to the Tax Foundation. Roughly 80 percent of families with kids have one or two children, according to the Census Bureau. These families would do better under a plan with a lower rate than one with a $2,500 credit, especially considering the benefit they see will grow over time, while the credit will likely remain fixed.
The senators argue a higher child credit is necessary because parents pay into old-age benefit plans like Social Security and Medicare twice: first with their own payroll taxes and again by bearing the expense of raising children who will pay into those programs in the future.
Lower taxes for parents would compensate for those costs, and therefore reduce a bias against childbearing, so the thinking goes. This is a novel attempt to extend the central principle of tax policy — neutrality — to the question of family size. But neutrality should remain applicable only to economic considerations.
If the two senators chose a consumption base and dropped the child credit expansion in favor of lower rates, their plan would be considerably more effective. Those improvements, paired with overdue reforms to our business tax system, would give a major lift to the economy.
• Curtis Dubay is a research fellow specializing in tax issues for The Heritage Foundation’s Roe Institute of Economic Policy Studies.
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