House Ways and Means Chairman Charles Rangel has revealed the details of his plan for sweeping tax reform. As the Wall Street Journal observes, the plan has the virtue of making it clear what we might expect from a Democratic victory in the next election. It’s essentially a return to the tax policies and resulting stagflation of the 1970s.
The package is complex, and the static revenue estimates that relate its various parts are worse than useless, so let’s just look at the pieces individually:
- Reduce the corporate tax rate from 35% to 30.5%. That’s an excellent idea. Our corporate tax rate is one of the highest in the world, and provides a strong incentive for companies to locate offshore. Compliance costs are vast. A better idea would be to eliminate the corporate income tax altogether. (Remember when Ronald Reagan proposed that? Reporters took it as one more crazy Reagan idea, but, to their amazement, found that the economists they interviewed liked it.)
- Eliminate the Alternative Minimum Tax. I’m no fan of that tax—I was caught by it last year—but it actually has a number of virtues. It’s close to a flat tax with few deductions. It’s beginning to catch lots of middle-class people only because (a) Bill Clinton and the Democrats in Congress raised the AMT rates early in his Presidency and (b) amounts that trigger the tax have never been increased to compensate for inflation. Reduce the tax rate to its 1992 level, update and index the triggers, and the tax would go back to applying to relatively few people. Instead, Rangel proposes its elimination. What’s the difference? The AMT often hits people who have large deductions, including large state and local tax bills and large amounts of mortgage interest. Eliminating it subsidizes people in high-tax blue states such as New York and New Jersey as well as people in expensive real-estate markets who borrow heavily. I don’t see why the federal government should subsidize high state taxes or high real estate prices, so I don’t see elimination of the AMT as particularly desirable.
- Apply a 4% surcharge to couples earning over $200,000 and a 4.6% surcharge to those earning over $500,000. That would raise the marginal tax rate of those earning $200,000-336,550 to 37%; $336,551-500,000, to 39%; and over $500,000, to 39.6%, effectively reversing the Bush tax cuts. [UPDATE: I missed the fine print, that this is in addition to reversing the Bush tax cuts. The rates would actually rise to 39%, 43%, and 44%, respectively.] Whether this would raise much revenue is doubtful, since people with high incomes tend to have choices about how much to take as taxable income. What it would do, surely, is slow economic growth. Moreover, though this will be sold as raising taxes on the rich, a couple making $200,000 in most urban areas is unlikely to feel rich.
- Raise the tax rate on capital gains from 15% to 19.6%. This is unlikely to raise the revenue Rangel projects; indeed, it’s likely to lose money. Every increase in the capital gains tax rate over the past 30 years has lost money; every decrease has made money. The reason is two-fold. First, lower capital gains rates encourage people to take profits and sell stock, moving capital to more productive uses. Higher rates encourage them to maintain their holdings, even if there are more productive uses of their capital. The result of higher rates, then, is fewer trades, and so less to tax, as well as lower economic growth as capital is held in less productive investments. Lower economic growth makes holdings less valuable, moreover, so the value of investments actually declines. Second, that indirect effect is coupled with a direct effect as taxes are built into stock prices. A thousand points off the Dow, anyone?