Realistic Tax Reform Can Deliver Real Growth

The central questions in the tax reform debate are whether tax reform can spur greater investment and economic growth; will that translate into higher wages and standards of living; and can this be accomplished in a fiscally responsible fashion? Research by the American Action Forum (AAF) indicates that well-designed, growth-focused tax reform can deliver on all these fronts, making the United States a better environment in which to invest, work, and live. Based on analysis performed by noted accounting firm EY, tax reform similar to that being considered by Congress would increase Gross Domestic Product (GDP) by over 3 percent – reflecting substantially higher investment – and lead to more than 7 percent higher after-tax wages for working Americans and an improved standard of living. Given sufficient attention to permanent, pro-growth provisions and aggressive base broadening, the reform can also avoid adding to the federal debt.

To quantify the potential economic gains from tax reform, AAF retained EY to perform a macroeconomic analysis of a complete tax proposal reflecting the provisions identified in the Unified Framework for Tax Reform. Where the Framework was silent on detail, AAF specified the missing tax parameters. The AAF proposal is therefore neither the House nor Senate tax bills, but rather a fully detailed individual, business, and international tax reform that is a close cousin of the tax legislation being debated in Congress.

The AAF plan assumes a 20-percent corporate tax rate; an income tax rate structure of 12, 25, and 35 percent; a pass-through tax rate of 25 percent, permanent expensing for qualified property, a move to a territorial international tax system, and substantial elimination of individual tax expenditures. Excluding the effects of economic growth, the plan would lose $1.1 trillion over the next 10 years.

The AAF plan does not pretend to be an ideal tax plan. There are myriad academic studies that identify more efficient tax reform proposals that are reference points for sound tax reforms. However, sweeping legislation always reflects the political reality of compromises and tradeoffs. The House and Senate tax bills are no different, and because the AAF plan is similar to these proposals, it is similarly imperfect. But the EY analysis demonstrates that an imperfect, realistic tax plan can still contribute to economic growth and prosperity.

According to EY, the AAF plan would unambiguously raise economic growth over the short, medium, and long-term, with the long-term GDP increasing by 3.1 percent. This reflects an average of the results produced by EY’s economic models. At the high end, the AAF plan could improve the economy by 4.5 percent. These GDP figures are abstract concepts – neatly but blandly expressing the dynamics of the world’s most vibrant economy. But associated with these abstract growth figures are higher wages – a 7.2 percent increase and a better standard of living – marked by a 3.5 percent increase in consumption over the long term.

The faster growth substantially changes the budgetary consequences of this proposal. The higher associated economic growth would generate higher revenues flowing back into the Treasury. This revenue feedback effect would amount to between about $660 and $690 billion, substantially offsetting the “static” budget cost of $1.1 trillion. The remaining $410-$440 billion over the next ten years is roughly the cost of making tax policies that Congress routinely extends permanent. In short, this proposal is revenue neutral against a “current policy” baseline.

In its latest projections, the Congressional Budget Office estimates that the U.S. economy will grow at a pace of about 1.9 percent a year for the next decade. At this rate, the American Dream would remain out of reach for many. Indeed, the most recent comprehensive income survey conducted by the U.S. Census Bureau found that income gains for households with full-time, full-year workers was precisely zero – this despite being over 8 years into the recovery from the Great Recession. Sound policy reforms, beginning with tax reform, are essential to changing this outlook – delivering higher growth, better wages for workers, and a higher standard of living for Americans.

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