Median family incomes are down 6% since 1999, according to research firm Sentier. Now you can pick at that number, I suppose, but few would argue that the past 15 years have been good ones for middle-class America.
So why are some folks on the right against giving middle-class families a big tax cut and letting them keep more of what they earn? The plan outlined by economist Robert Stein in the conservative policy book “Room to Grow” – a book to which I contributed a chapter – would expand the child tax credit so that a married couple with two kids making $75,000 a year would get a $5,000 tax cut. Now Cato’s Dan Mitchell, in a Wall Street Journal commentary today, concedes Stein’s idea would indeed help middle-class families right now, especially versus a reduction in tax rates, “which would have only a modest impact on take-home pay for a family in the 10% or 15% tax bracket.” Yet Mitchell still thinks cutting marginal tax rates is the better idea:
The more effective policy—at least in the long run—is to boost economic growth so that families have more income in the first place. Even very modest changes in annual growth, if sustained over time, can yield big increases in household income.
I am not so sure about that.
1.) House Ways and Means Chairman Dave Camp has put forward tax reform with a top rate of 25% vs. 40% today. Yet his plan would likely increase the economy’s size by less than 1% over the next decade, according to the Joint Tax Committee. Marginal rates in the 35%-to-40% range are simply not as much a disincentive to productive activity as the 70% top rate that existed when President Reagan took office. From 1987 through 1992 — after the much ballyhooed 1986 tax reform — the top marginal rate was around 31%, yet real GDP growth averaged just 2.8%. And from 2003 through 2007 when the top marginal rate was 35%, GDP growth averaged 2.9%. This is not to say lower tax rates aren’t good for economic growth. But marginal rates at those levels are almost certainly already deep on the good side of the Laffer Curve. Also, while it’s true that other things were happening in the economy during those years, that’s the point. The top tax rate isn’t the only factor influencing economic growth, either short- or long-term.
2.) And consider this: just how would the GDP gains, such as they are, from cutting top marginal rates be distributed in an economy where middle-wage jobs are disappearing and income gains are tilted toward the highly skilled and educated? The US economy needs to grow faster, but faster growth alone in the Age of Automation may not substantially increase living standards for a larger swath of the American people. That reality is a big difference between the 2010s economy and the 1980s economy, one many on the right have yet to grasp. Cranking up GDP growth is necessary but not sufficient.
3.) Mitchell asserts, “Tax-credit conservatives generally admit that child-oriented tax cuts have few, if any, pro-growth benefits.” That’s not true. In addition to raising take-home pay — which by itself is reason enough to embrace the Stein plan — expanding the child tax credit would serve as a sort of human-capital gains tax cut for worker creators (also known as families). It might just be nudge enough for financially-stressed families to have another kid since surveys suggest parents don’t have as many as they would otherwise prefer due to money concerns. Modern pro-growth policymakers should fret as much about the nation’s birthrate as productivity and labor-force participation rates. Lower birthrates and older populations are associated with less economic growth. A younger American society with a higher birth rate, helped by a tax code that offsets anti-family government policy, would be more dynamic, creative, and entrepreneurial.
4.) To give Mitchell some credit here, he does acknowledge there is more to the conservative-reform tax agenda than the child tax credit:
While the camps disagree on lower individual income tax rates vs. child-oriented tax relief, both agree that the tax code’s bias against capital formation is very misguided. The logical compromise might be to focus on reforms that boost saving and investment, such as lowering the corporate tax rate, reducing the double taxation of dividends and capital gains, and allowing immediate expensing of business investment.
Indeed, here is Stein in his 2010 National Affairs piece, where he first sketched his tax reform plan:
First, to remove impediments to capital investment, we should adopt Columbia Business School dean Glenn Hubbard’s proposal to let companies take the profits on which they pay taxes — plus interest earned from tax-free municipal bonds — and distribute them to shareholders tax-free. Corporate profits would therefore no longer face two layers of taxation, just one. Additionally, capital investment should be promoted by letting companies count 25% of plant and equipment spending as business expenses in the year the purchases are made, rather than using the current slower depreciation schedules. Cutting the effective tax rate on capital investment would encourage equity financing of new investment, raise workers’ wages, create new jobs, and improve the competitiveness of American firms.
5.) Let me add that there is more to the conservative reform agenda for the middle class than just tax reform, including regulatory, health care, K-12, and higher-education reform. And there should be more to the supply-side, pro-growth agenda than cutting marginal tax rates, including reducing crony capitalist barriers — such as Too Big To Fail megabank subsidies and overly strong copyright and patent laws — to the creation of innovative, startup companies that produce new goods, services, and jobs and keep mature firms on their toes. American needs more growth, and worker creators (strong families) are just as important to achieving that as job creators (strong companies). Let’s have both.
Follow James Pethokoukis on Twitter at @JimPethokoukis, and AEIdeas at @AEIdeas.