Tax reform offers a chance for Republicans to accomplish several objectives at once: promoting economic growth, providing middle-class tax relief, simplifying the tax code, and — rising in importance — showing that they are capable of getting something done.
They now have a “framework” for legislation. It includes many useful and productive steps, especially in the area of business taxation, where it makes the U.S. a more attractive place to invest for Americans and foreigners alike.
As they move from the framework to an actual bill, though, Republicans will have to contend with four political problems, some of which are also substantive problems. These issues largely arise from changes to the tax code for individuals. The Republican bill could fail to cut middle-class taxes, or it might even raise them for many families. It could alienate too many blue-state Republicans to pass. It could increase the deficit enormously. And it could cut taxes for the rich too much.
It may be possible to overcome these obstacles while keeping the framework — but not without paying a price.
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The political problem Republican legislators need to fix most urgently is that their outline leaves the impact of tax reform on middle-class families unclear. It commits to a big expansion of the standard deduction, which would be $12,000 for singles and $24,000 for families. It endorses a “significant” increase in the child credit. But it also abolishes the personal exemptions and raises the tax on the first $9,300 of taxable income from 10 to 12 percent.
The net effect of this change depends on how much the child credit is expanded. If it rises by less than $1,000, a lot of middle-class families will see a tax increase. In that case it will also be hard to label the tax plan “pro-family,” as Republicans usually want to do, since it will mean that tax relief per child will actually shrink.
Doubling the child credit, and making it apply against payroll taxes, would solve this problem. It would also help with the second problem: Republican congressmen from high-tax states whose constituents would lose from the abolition of the deduction for state and local taxes. A bigger child credit would compensate a lot of these congressmen’s constituents for losing that deduction.
But a bigger child credit would also make the third problem, the deficit, bigger. The Republican framework creates some room for solving that one. It cuts the top tax rate to 35 percent, but mentions that a surtax might be imposed on “the highest-income taxpayers” to make the reformed code more progressive. That would also be a way to keep the deficit from rising too much. Another way, also consistent with the framework, would be to have the 35 percent rate kick in at a relatively low level, so it applies to a larger share of the income of upper-end taxpayers.
Beyond that, Republicans might have to scale back some of their tax cuts. They could bring the corporate rate to 25 percent instead of 20, tax pass-through businesses at 30 percent instead of 25 or leave the top tax rate at 39.6 percent. These steps would also reduce the power of the “tax cut for the rich” charge against Republicans.
Republicans won’t want to do any of those things. But they are probably going to have to choose. And it can’t be middle-class interests that they sacrifice, even though some Republicans consider broad-based tax relief a distraction from the imperative of promoting economic growth.
A tax reform that leaves out the middle class while cutting taxes for the rich won’t just be unbalanced. It will be unviable, too. A bill that fails won’t do anything for the economy, or for Republicans.