What would a President Romney have done about the approaching fiscal cliff, not to mention the long-term need for debt reduction? An FT op-ed today by Romney economic adviser (and AEI scholar) Glenn Hubbard may give some clues. The Hubbard Plan is based on two main principles — raise average tax rates on the wealthy not marginal tax rates, and focus debt reduction on spending cuts not tax increases — resulting in several quasi-specifics:
– Limit tax preference benefits for upper-income households perhaps via caps on the amount of deductions relative to a taxpayer’s income.
– Cut spending over a decade via decreases in the growth of defense and non-defense discretionary spending. Also, increase the retirement age for Social Security benefits
– Decide how big we want government to be and tax accordingly:
The present tax system can raise at most about 20 per cent of GDP in a booming economy. A government of, say, 25 per cent of GDP cannot be paid for by changing rates in such a system. The distortions would be too great. Rather, as in most other advanced economies, a universal consumption tax would be required. (Such a tax would also enable reductions in individual and corporate income tax rates.) An alternative route – superior from the perspective of growth – would be to reduce benefit expenditure over time for the non-poor. This would allow for both a lower tax burden and for investments in education, research and development, and infrastructure.
A few thoughts:
1. Base broadening is not some free lunch. If you leave statutory marginal rates unchanged and scale back tax breaks, you might very well be raising effective marginal tax rates.
2. Not all tax breaks are created equal, and you need to be on the lookout for unintended consequences. Three of the largest tax expenditures are the reduced tax rate on dividends and capital gains, the tax preferences for defined benefit plans, and the tax preferences for defined contribution plans. They tend to promote efficiency and reduce current income tax code’s penalty on saving by treating current and future consumption more neutrally. Base broadening that kills or limits them would damage economic efficiency. Folks shouldn’t be so quick to want to tax capital gains or dividend income as the same level as ordinary income.
3. Here is a nice summary on the way forward by AEI’s Alex Brill and Alan Viard;
Base broadening and statutory rate reductions are not ends in themselves. Like other tax policies, these reforms should be evaluated by whether they promote efficiency, simplicity, and fairness.1 Revenue-neutral base broadening can be useful if it is done properly. Priority should be given to reducing the largest distortions, such as the preferences for employer provided health insurance and owner-occupied housing. Tax preferences should be preserved for work-related costs, and it is particularly important to avoid increases in the tax penalty on saving. In fact, policymakers should consider using part of the revenue raised by base broadening to reduce the tax penalty on saving.