Tax reform that broadens the tax base, reduces unfair and distorting loopholes and deductions, and cuts marginal tax rates promises to grow the economy. Yet Congress is considering undermining the full potential of tax reform because of pressure from special interests.
Eliminating a federal tax policy that provides an income tax break of nearly $200,000 to millionaires living in New York and California while requiring higher marginal rates for everyone else is a perfect example of achieving that pro-growth objective.
The proposed House and Senate tax reform bills did away with much of that economically destructive subsidy for state and local taxes by limiting it to a maximum property tax deduction of $10,000. But now, lawmakers are considering caving to the special-interest demands of a few of their colleagues from high-tax states such as California, New York, and New Jersey.
Those who are hijacking pro-growth tax reform want the federal government to subsidize the largesse of their own state governments. Making taxpayers in lower-tax states pay for the goods and services provided by high-tax states is neither fair nor good tax policy. And it just might encourage states to raise their taxes even higher.
Increasing state and local tax deductions reduces tax revenues, and therefore requires higher taxes elsewhere to bring in the same amount. Instead of reducing the corporate tax rate to 20 percent, lawmakers now are considering increasing that proposed new rate to 22 percent to pay for these special-interest tax provisions. The current rate is 35 percent.
A business tax rate higher than 20 percent would negatively affect Americans across all states and all income levels. It would make U.S. businesses and the workers they employ less competitive with the rest of the world than they would be with a tax rate of 20 percent or lower.
That is the opposite of pro-growth tax reform. Trading a special-interest tax deduction that encourages bad economic policy (higher state and local taxes) for a higher rate on one of the most economically destructive taxes—the corporate tax—is a horrible idea.
Corporations don’t pay taxes, people pay taxes. The people who pay corporate taxes include workers, shareholders, and consumers. And those shareholders include not only wealthy investors but also retirees, nonprofits, and anyone with a pension or retirement account.
Recent studies provide growing evidence that in an open economy such as the U.S., workers bear a majority of the corporate tax in the form of lower wages—and this share is increasing.
Raising the corporate tax rate above the proposed 20 percent level that both the House and Senate previously stipulated would result in smaller paychecks and fewer jobs for workers who are employed by those corporations, higher prices for everyone who purchases goods and services from those corporations, and lower dividends and capital gains for shareholders of those corporations (many of whom are retirees).
That’s a big price to pay for providing a subsidy to a small fraction of wealthy taxpayers in high-tax states.
Very few low- and middle-income taxpayers would benefit from a higher state and local tax deduction, because not many of them currently itemize their deductions and even fewer would under the roughly doubled standard deductions of the reform proposals.
In fact, because of the higher standard deductions, The Heritage Foundation estimates that fewer than 6 percent of taxpayers who make less than $100,000 a year would benefit from keeping the state and local tax deductions.
Among those making between $50,000 and $75,000, only 4 percent would benefit. And among those in the $25,000 to $50,000 income range, fewer than 2 percent would benefit.
Lawmakers need to return to the principles of pro-growth tax reform and reject special-interest and economically destructive provisions that would benefit a small minority of wealthy taxpayers at the expense of lower wages, fewer jobs, smaller returns on investments, and higher prices for all Americans.