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The GOP Budget: Zero Deficit and Tax Reform

Things are moving on Capitol Hill. Not only have the Republicans presented a budget for FY2016 with a fiscal plan to balance the budget in nine years, but they have also opened for good, solid tax reform.

This is very important. It is absolutely critical that Congress ends its almost-chronic addiction to deficits. A balanced budget is necessary per se in order to put our economy back on a path to prosperity for coming generations. However, it is far from sufficient. Regardless of whether the budget balance is accomplished through annual efforts, as in the GOP budget, or through a balanced-budget amendment, its long-term benefits can only be guaranteed if it is combined with long-term spending reform and growth-friendly tax reform. 

Of these two, tax reform is the more urgent. In their FY2016 budget the Republicans recognize this.

No doubt, eventually Congress must execute fundamental reforms to entitlement programs. I will leave that aside for now - for those interested in realistic reform ideas, please see my book Ending the Welfare State: A Path to Limited Government That Won't Leave the Poor Behind. However, tax reform is of even higher priority. Our economy is growing slowly compared to where it could be, and over the short term taxes are more harmful to private-sector activity than big, complex entitlement systems. Long-term, entitlements are at least as harmful, but if we do not start with reforming our tax system there is very little point in reforming entitlements. Tax reform will give us a short-term boost in growth, allow the private sector to thrive and thus create a good basis for entitlement reform down the road. 

In the concurrent resolution report on the budget, the GOP spends two pages on tax reform (pp. 129-130). This may not seem like much, but they do have some compelling things to say there. They want to simplify the tax code, substantially lower rates for individuals, have fewer brackets, repeal the Alternative Minimum Tax and reduce the corporate income tax rate. 

While there are no specifics beyond the AMT repeal, the resolution report speaks favorably of Representative Woodall's FairTax proposal. Presented in H.R. 25, Woodall's proposal for tax reform - which has more than 50 co-sponsors in the House - would replace income, payroll, estate and gift taxes with a consumption-based tax system. The national sales tax would apply to both goods and services, eliminating the artificial distinction between sales and use taxes still in effect at the state level. It would also apply "to all consumption of goods and services in the United States once, without exception, but only once".

There are two appealing aspects of this tax. The first is its simplicity and transparency: anyone proficient in middle-school arithmetic will be able to calculate his annual tax payments just by keeping track of his spending over the course of a year. No more multi-page tax return filing, no more spending hundreds of dollars on tax accountants and tax advisors. This will save American households and small businesses filing as individuals an enormous amount of money and time every year.

Secondly, and even more importantly: this is a proposal for a one-stop taxation system. Today, as a dollar moves through the economy, it is subject to tax multiple times. Under the FairTax model, the dollar would be subject to taxation at one, and only one, point on its travel through the economy. Since that point is an unavoidable economic activity - private consumption - every American will participate. Even those who today evade income taxes by working off the books will have to pay the consumption-based sales tax. 

There is no secret that taxes are distortionary: every economic activity that is subject to a tax is also somewhat depressed because of the tax. By concentrating taxation to one point, and one point only, in the economy, this reform would alleviate every other economic activity - work, investment, savings, property ownership - by removing the federal tax burden. This will open for a major increase in business investments, private savings and labor supply. The private sector will become much wealthier over time, which is good for both economic growth and for future entitlement reforms.

From the viewpoint of a Balanced-Budget Amendment, the Woodall tax reform idea is particularly appealing. while the Republican FY2016 budget does not propose a BBA, it does aim to balance the budget in nine years. Their plan hinges in part on a growth boost, which they would be guaranteed if they went ahead with Woodall's FairTax plan. Not only would a one-stop tax system be very growth friendly in itself, but at least as importantly, the combination of a balanced budget and consumption taxes is good for macroeconomic stability. There is plenty of research and indisputable macroeconomic evidence to show that any attempts at combining progressive income taxes - which is what we have today - with concerted efforts at budget balancing will only lead to macroeconomic instability.

Again: consumption taxes and a balanced budget go well together from the perspectives of GDP growth and macroeconomic stability. 

Alas, overall the GOP has presented a strong budget with some real promise of good fiscal policy and ideas of tax reform. But all is not good - there is one particular issue that I need to address, and that has to do with the concept of "revenue-neutral fundamental tax reform" which the budget resolution report proudly talks about on page 129. But that will have to be the subject for another article.


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