If the tax reform proposal of Rubio and Lee were to pass it would easily be the best thing the Federal government has done since the civil rights laws of the 1960s. And yet we see the usual suspects like Jonathan Chait trashing the bill. Instead Chait should have said that with one tweak the bill would be awesome, and Dems like Elizabeth Warren should be racing to support the general idea. I’ll get to the minor tweak in a moment, but first some of the good things it does:
1. Ends the marriage penalty.
2. Ends the taxation of capital income.
3. The corporate tax becomes based on income earned in the US, (which is the approach used by most other countries.) The rate would be similar to European tax rates. Interest would no longer be expensed. (Recall that interest income is no longer taxed (point #2), so it balances out.)
4. Capital investments are expensed, no depreciation schedules.
5. Ends most itemized deductions.
6. AMT eliminated.
I haven’t been this excited since I was single!
Is it perfect? No, there’d still be deductions for health insurance and mortgage interest and charitable deductions. However their statement says those issues also need to be addressed. They should also treat everyone as single, to end the marriage bonus.
Under Rubio/Lee, someone like me with no mortgage would have the following 1040:
Wage income minus charitable contributions = taxable income.
The tax code would no longer hammer savers and married people. It basically turns the income tax into a progressive consumption tax. Isn’t a progressive consumption tax what liberals have been calling for?
Now for the supposed flaws.
1. It’s not progressive enough.
2. It doesn’t raise enough revenue.
There’s a very simple fix for both problems—add a third bracket! The proposal calls for a 15% rate up to $75,000, and 35% above that level (or above $150,000 for couples.) Simple solution—add a 50% rate for income above $250,000 (or $500,000 for married people.)
A note on progressivity:
Liberal arguments on the progressivity of various tax changes are basically worthless. Ignore everything you read, as they are using “income” as the benchmark of economic well-being. Thus suppose I earn $100,000 a year for 20 years, and then sell my house for a capital gain of $500,000. (I live in a two family, so I must pay taxes on the gain.) Liberals would have you believe I am suddenly “rich” in the year of the sale, with an income of $600,000. That’s nonsense for two reasons. The actual gain occurred gradually over 20 years. And adding wage and capital income is as nonsensical as adding blueberries and apples, and calling it the number of “fruit.” Taxes on capital income are double taxing the same earnings.
Conservatives might complain that a 50% top rate is too high. The current top rate is 43.4% (don’t believe the liars who claim it’s 39.6%.) But that is the top rate for an income tax system. Rubio and Lee are proposing that we switch to a consumption tax system. Consumption is less than income, especially for the rich, or should I say the “rich.” (How much will I consume the year I finally sell my house? Not $600,000.) So the top rate should be higher with any switch to a consumption tax. Indeed you can argue that people with consumption levels in the $100s of millions per year should face an even higher tax rate. And don’t tell me they “deserve” the 500 yachts earned through legal barriers to entry like intellectual property laws, there is no such thing as “deserve” in a cold heartless universe composed of nothing but subatomic particles, where most people are born into peasant families in places like Nigeria and Bangladesh. If conservatives won’t be hardheaded realists, who will be?
Yes, I’d prefer a lower set of tax rates. I wish our total government spending were 20% of GDP, like the 4 Asian tiger economies, not the 35% to 40% we seem stuck with. I wish we’d eliminate the tax deductibility of mortgage interest and health insurance, which would allow for lower rates than what I’m proposing. Ideally the government would simply withhold income taxes, like they do with the payroll tax. No 1040 forms to fill out.
The other potential flaw in Rubio and Lee is business/self-employed income, and especially preventing tax avoidance. An alternative way to a progressive consumption tax would be to treat all savings and investment in a 401k-type structure, taxing income only when it is consumed. That would make it much harder for the hedge fund guys and the self-employed to avoid taxes.
PS. I have a new post on inequality at Econlog.