Big, Credible Tax Reform
Tax reform is at the top of the Trump administration’s agenda, and Republicans in Congress have long awaited an opportunity to present growth-oriented tax reform to a president willing to sign it. Throughout the campaign, Donald Trump claimed that his tax reform bill would get the economy growing at a faster rate, which would create jobs and improve Americans’ economic situations.
Trump is right that economic growth should be the goal of tax reform, and that’s the lens through which we should evaluate the current controversy over whether tax reform should be revenue-neutral, or whether we should accept a tax reform plan that actually cuts taxes overall and thus loses federal revenue.
The budgetary and fiscal rules of the last couple of decades put an emphasis on revenue neutrality. In other words, tax reform can rearrange the pieces of the tax code so long as the overall reform is scored as providing the same amount of revenue as the pre-reform tax code. These rules have been driven by entirely reasonable concerns about budget deficits and perpetually adding to the national debt.
Here’s the problem: If economic growth is our standard of success, revenue neutral tax reforms don’t have a history of stimulating much economic growth. The last major US tax reform, the tax reform of 1986, frankly didn’t do much in terms of stimulating additional economic growth. Neither did the two Bush tax cuts in 2001 and 2003.
On the other hand, significant tax cuts have a history of stimulating significant economic growth. Neither the 1962 Kennedy tax cuts nor the 1981 Reagan tax cuts were revenue neutral. And yet the Kennedy tax cuts succeeded in stimulating eight years of 5 percent average economic growth.
The 1981 Reagan tax cuts more than paid for themselves over seven years. They did so by creating 92 months of economic growth without a recession, with a sustained period averaging 4.4 percent economic growth from 1983 to 1989. By contrast, the Obama years never cracked 3 percent economic growth.
Recent notable tax reform efforts in the UK and Sweden have also not been hobbled by a requirement to be revenue neutral. Instead, reformers fully intended to reduce the tax burden on the economy, with the understanding that increased economic growth would, over time, more than compensate for lost revenue.
So if economic growth is the goal, tax reform need not be revenue neutral—in fact, if it is, it probably won’t stimulate much economic growth.
Republicans should not trap themselves within the strait jacket of revenue neutrality, and when the criticisms come, they should clearly explain that the goal is economic growth, not revenue neutrality. But, in order for such large tax cuts to be credible to the American people and consistent with Trump’s campaign rhetoric and Republican fiscal discipline, they must be paired with serious, structural spending restraints designed to ensure that we take full advantage of increased economic growth to reduce budget deficits and at least stop adding to the national debt.