Last night, Senator Marco Rubio (R-FL) suspended his campaign. While this is the end of the road for him, many of the policies Rubio proposed may live on. One such proposal that may stick around is his taxA tax is a mandatory payment or charge collected by local, state, and national governments from individuals or businesses to cover the costs of general government services, goods, and activities. plan.
Rubio’s tax plan was a modified version of what is called the “X-tax,” a tax reform plan developed by the late economist David Bradford. The X-tax would move the current tax system to a consumption-based tax (much like a VAT, retail sales taxA sales tax is levied on retail sales of goods and services and, ideally, should apply to all final consumption with few exemptions. Many governments exempt goods like groceries; base broadening, such as including groceries, could keep rates lower. A sales tax should exempt business-to-business transactions which, when taxed, cause tax pyramiding. , or flat taxAn income tax is referred to as a “flat tax” when all taxable income is subject to the same tax rate, regardless of income level or assets. would).
Rubio’s plan would have pretty much eliminated the current tax code’s bias against saving and investment with three significant changes:
- Full expensingFull expensing allows businesses to immediately deduct the full cost of certain investments in new or improved technology, equipment, or buildings. It alleviates a bias in the tax code and incentivizes companies to invest more, which, in the long run, raises worker productivity, boosts wages, and creates more jobs. of capital investment
- Elimination of individual capital gains, dividend, and interest taxation
- Elimination of the deductibility of interest expenses
On top of this, Rubio’s plan would have reduced the marginal tax rateThe marginal tax rate is the amount of additional tax paid for every additional dollar earned as income. The average tax rate is the total tax paid divided by total income earned. A 10 percent marginal tax rate means that 10 cents of every next dollar earned would be taken as tax. on corporate income from 35 percent to 25 percent, eliminated the estate and gift taxA gift tax is a tax on the transfer of property by a living individual, without payment or a valuable exchange in return. The donor, not the recipient of the gift, is typically liable for the tax. , moved to a territorial tax systemA territorial tax system for corporations, as opposed to a worldwide tax system, excludes profits multinational companies earn in foreign countries from their domestic tax base. As part of the 2017 Tax Cuts and Jobs Act (TCJA), the United States shifted from worldwide taxation towards territorial taxation. , and eliminated most special credits and deductions for businesses.
When we modeled the plan, we found that it would have increased the long-run size of GDP by 15 percent, increased the size of the capital stock by 49 percent, and resulted in 12.5 percent higher wages.
One issue with consumption-based taxes is that they can be much more regressive than the current tax system. Yet, a key feature of the X-tax and Rubio’s plan is that it starts from a consumption base, but maintains a degree of progressivity. It does this by taxing wages at progressive rates instead of at one, flat rate. Rubio’s plan taxed wages at three rates: 15, 25, and 35 percent. Rubio’s version of the X-tax went a little bit further by replacing the standard deductionThe standard deduction reduces a taxpayer’s taxable income by a set amount determined by the government. It was nearly doubled for all classes of filers by the 2017 Tax Cuts and Jobs Act as an incentive for taxpayers not to itemize deductions when filing their federal income taxes. and personal exemption with a per-filer refundable tax creditA refundable tax credit can be used to generate a federal tax refund larger than the amount of tax paid throughout the year. In other words, a refundable tax credit creates the possibility of a negative federal tax liability. An example of a refundable tax credit is the Earned Income Tax Credit. of $2,000 and by enacting a new $2,500 refundable child tax creditA tax credit is a provision that reduces a taxpayer’s final tax bill, dollar-for-dollar. A tax credit differs from deductions and exemptions, which reduce taxable income, rather than the taxpayer’s tax bill directly. . These two provisions made the plan even more friendly to low- and middle-income taxpayers
These features resulted in tax cuts for all income levels, and for some at the bottom, the tax cuts were significant.
Rubio’s plan didn’t come without some challenges. One such challenge with Rubio’s plan is that it exempted capital gains and dividends from taxation at the individual level. Economically, the reason to do this is obvious. These taxes represent a double tax on corporate income, and without a deduction for saving, these taxes place a heavier burden on future consumption than present consumption. However, the politics are tricky. People that receive only capital gains and dividends income, who are typically very wealthy, would end up not remitting any tax personally.
The plan also contained a special, reduced rate for pass-through businessA pass-through business is a sole proprietorship, partnership, or S corporation that is not subject to the corporate income tax; instead, this business reports its income on the individual income tax returns of the owners and is taxed at individual income tax rates. es. This provision was meant to equalize the treatment of corporate and non-corporate businesses, but many were concerned about the possibility of tax avoidance by individuals. Someone with wage income that would be taxed at the top rate of 35 percent in Rubio’s plan could become an independent contractor and would immediately pay less in taxes by only being subject to a maximum rate of 25 percent.
Another issue was that the Rubio plan would have been a pretty large tax cut. We scored it as a $6.1 trillion tax cut over a decade. If we account for the economic growth of going to a pure consumption-based tax, the plan would still reduce federal revenues by $2.4 trillion. One of the reasons the plan reduced revenues so much is the new child tax credit included in it. This provision alone would reduce federal revenues by about $2 trillion over a decade, without contributing to economic output in any meaningful way. In order to make the plan work, Rubio would have needed to scale back the tax cut by raising marginal rates, or would have had to cut federal spending significantly.
Although Rubio’s campaign has ended, lawmakers can still learn a lot from its tax plan. Perhaps a plan like Rubio’s could be a starting point for reform in the future.Share