A tax reform proposal introduced by Republican Sens. Mike Lee and Marco Rubio will test the GOP proposition that lowering and simplifying taxes can pay for itself.
The proposal announced this month by the two conservatives is an ambitious effort to overhaul the outdated and labyrinthine tax code in a way favorable both to business and families.
They would slash individual and corporate tax rates, and ramp up a tax credit for children. In an effort to stimulate commerce, the senators would zero out taxes on capital gains and dividends while allowing businesses to immediately deduct investments.
To pay for those radical reductions in tax rates, the Rubio-Lee proposal would eliminate almost all the tax breaks in the code.
Doing so would raise revenue, but early assessments of the plan by outside experts suggest that it would not raise enough taxes to offset, on paper, the the tax cuts included in the plan. That’s where dynamic scoring comes into play.
When Congress needs an estimate of how much federal revenue a tax bill will lose, it turns to the Joint Committee on Taxation. Normally, the committee produces a “static analysis” estimate using the assumption that the bill will not affect economic growth.
Dynamic scoring, instead, includes the possibility that lowering taxes or removing distortions in the tax code could boost economic growth, leading to higher tax revenue as well as higher incomes for businesses and workers. It has long been favored by Republicans, who see tax cuts as the key to economic growth.
Past estimates of measures similar to the Rubio-Lee proposal suggest that it could lose the Treasury anywhere from $2 trillion to $4 trillion or even more. The question is how much of that would be made up in a dynamic analysis.
“I think it’s unfair to score a pro-growth tax plan without taking into account growth,” said Rubio, who represents Florida and has presidential ambitions, while introducing the bill.
The senators made it clear that they would not stipulate that tax reform have a neutral effect on the deficit, a condition set by Republicans such as former presidential candidate Mitt Romney and former House Ways and Means Committee Chairman Dave Camp when they devised their own plans. Instead, Lee, who represents Utah, and Rubio would plan on reforming spending on entitlements such as Medicare and Social Security. “We can’t tax our way out of this debt, and we can’t cut our way out of this debt alone,” Rubio said. “We have to do both.”
But the plan, which Rubio said was introduced to build momentum for an overhaul, would see its credibility harmed if it would require the assumption that Congress would simultaneously slash entitlement programs that Americans fiercely protect, putting pressure on dynamic scoring to bring the plan within range of deficit neutrality.
It is a stretch to think that dynamic scoring could fill in the fiscal hole created by the plan, as shown by one generous outside score.
The Tax Foundation last week found that the plan would massively accelerate economic growth. In 10 years, the economy would be 15 percent bigger with the plan than without.
“Rubio-Lee is filled with provisions that would be highly favorable to economic growth, and that explains why we got a very positive result for the proposals,” said Michael Schuyler, a Tax Foundation economist who performed the analysis.
In the Tax Foundation’s static analysis, the plan loses more than $400 billion annually. In a dynamic analysis, though, the plan would lose $1.7 trillion over the first 10 years, relative to the Congressional Budget Office’s projection that the government will take in $42 trillion over the same period. After those 10 years, however, the Tax Foundation sees the plan generating $94 billion annual in added revenue each year.
Other outside experts have questioned whether that level of added revenue is possible. It’s a far better dynamic result than Camp’s draft tax reform bill received when it was scored by the Joint Committee on Taxation last year.
Like Rubio-Lee, Camp’s bill would have lowered the top individual rate to 35 percent from the current 39.6 percent and the top corporate rate to 25 percent from 35 percent. The Joint Committee on Taxation found that it would have a neutral effect on the deficit over 10 years on a static basis. Using a dynamic analysis, it would generate between $50 billion and $700 billion, depending on which model of the economy and which assumptions about the Federal Reserve’s response were used.
Schuyler defended his analysis of Rubio-Lee as within mainstream economic assumptions, noting that the Tax Foundation’s dynamic score of Camp’s bill also found little impact.
The difference, he said, is that Rubio and Lee would encourage business investment, a major factor in models of growth, by drastically cutting back on tax disincentives.
Whereas the Camp draft plan would have raised capital gains taxes and lengthened the period over which businesses could write off the depreciation of machinery or other assets, Rubio-Lee would axe capital gains taxation entirely and allow companies to immediately write off their investments.
“We want them opening up new factories, we want them going into new lines of business, we want them buying new machines for their facilities,” Rubio said while introducing the plan.
The Tax Foundation’s guess is that businesses would respond to those lowered taxes by raising the stock of capital by a massive 50 percent. “You would expect a big uptick in investment, and that’s exactly what we found,” Schuyler said, noting that the Tax Foundation model is similar to one used by the Joint Committee on Taxation.
Nevertheless, other analysts have noted that the committee has, in the past, found smaller payoff for tax cuts for business investment.
For example, a House Republican bill introduced last year that would permanently establish a rule allowing businesses to deduct half the cost of equipment immediately was projected to add $287 billion to the debt over 11 years. The dynamic score showed that business would expand, but only enough to slightly offset those revenue losses.
