The Economic Effects of Rand Paul’s Tax Reform Plan

UPDATE: The 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. Foundation has updated its economic and revenue estimates for Rand Paul’s tax reform plan. The new estimates are based on the latest version of the Taxes and Growth (TAG) Model (the October 2015 version). More details on the update at the bottom of the page.

Senator Rand Paul (R-KY), a candidate for president, recently announced his plan to reform the U.S. tax code. His proposal, the “Flat and Fair Tax,” would move to a 14.5 percent tax rate on all types of income with a sizable deduction and exemption, eliminate the corporate tax to create a 14.5 percent business transfer tax paid by businesses on profits and wages, introduce 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. for investments in capital, and eliminate the payroll taxA payroll tax is a tax paid on the wages and salaries of employees to finance social insurance programs like Social Security, Medicare, and unemployment insurance. Payroll taxes are social insurance taxes that comprise 24.8 percent of combined federal, state, and local government revenue, the second largest source of that combined tax revenue. on both the employer and employee.

Our analysis finds that Senator Paul’s plan would grow the economy by 12.9 percent in the long run, create 4.3 million jobs, and cost $1.8 trillion over ten years on a static basis and raise $737 billion when accounting for economic growth.

Structure of the Tax Reform Plan

Sen. Paul would make a number of changes to the tax code for individuals. He would replace the current seven tax bracket structure with a flat rate of 14.5 percent and apply that tax rate to all income – wages and salaries, capital gains, dividends, interest, and rents.

The plan would include a $15,000 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 (TCJA) as an incentive for taxpayers not to itemize deductions when filing their federal income taxes. (per filer) and a $5,000 per person personal exemption. This means that a family of four would pay no income tax on their first $50,000 of income ($55,000 for a family of five, etc.).

Retirement accounts remain as they currently are and in our modeling we assumed that the exclusion for employer-provided health care remains.

The plan retains home mortgage and charitable deductions, the earned income tax credits, and the 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. and eliminates all other tax credits and deductions.

The plan would eliminate the payroll tax, the estate taxAn estate tax is imposed on the net value of an individual’s taxable estate, after any exclusions or credits, at the time of death. The tax is paid by the estate itself before assets are distributed to heirs. , and all customs duties and tariffs.

On the business side, the plan would eliminate the corporate tax, create a territorial type system, and introduce a 14.5 percent business transfer tax. This tax would be levied on a business’s factors of production and tax all capital income (profits, rents, royalties) and all labor payments (wages and salaries). All capital expenses (machines, equipment, buildings, etc.) are fully expensed in the first year, which would do away with current depreciationDepreciation is a measurement of the “useful life” of a business asset, such as machinery or a factory, to determine the multiyear period over which the cost of that asset can be deducted from taxable income. Instead of allowing businesses to deduct the cost of investments immediately (i.e., full expensing), depreciation requires deductions to be taken over time, reducing their value and discouraging investment. schedules. This tax would also apply to wages paid by governments and nonprofits.

The Economic and Revenue Estimates of the Plan

According to our Taxes and Growth Model, Senator Paul’s tax reform proposal would increase GDP by 12.9 percent by the end of roughly 10 years (it may be shorter or longer depending on how long it takes business to pull permits for new buildings, supply chains to adjust, etc.). This is equivalent to average additional growth of a little under 1.2 percentage points per year.

This growth is largely due to a cut in the service price of capital, which is a result of lower taxes on businesses and investment, specifically the tax cut to 14.5 percent on business profits, the 14.5 percent rate on capital gains and dividends, and the shift to full expensing. These tax changes result in an increase of the capital stock of 40.5 percent by the end of the adjustment period and results in higher after tax wages of 5.5 percent.

Additionally, the tax cut on wage income to 14.5 percent also increases the incentive to work and results in 3.5 percent additional private business hours of work. This is equivalent to 4.3 million full-time jobs.

On a static basis, Senator Paul tax reform plan would lose nearly $2 trillion over a ten-year period, with an average annual cost of about $200 billion. If we account for the growth of the economy, over time this would lead to smaller tax costs. We estimate that the plan would end up raising an additional $737 billion over the budget window.

Distributional Analysis

On a static basis, Senator Paul’s plan would increase after tax income a total of 4 percent across all taxpayers. When not considering growth, it would have little to no effect on after tax income for those making under $10,000 of income and increase after tax income to varying degrees for all other income groups.

The little to no change in after tax income for filers with AGI under $10,000 is due to the elimination of the payroll tax and how that would interact with the change in labor compensation due to the business transfer tax, which has a secondary effect related to the phase-ins of the child tax credit and the earned income tax credit. On the whole, many people in this income group would likely receive a tax cut.

On a dynamic basis, the plan would increase after tax incomes by a total 16 percent for all income groups. Filers with income below $10,000 would see their income increase by over 10 percent. Taxpayers in income groups between $20,000 and $75,000 would see their incomes go up by about 14. Those with incomes above $500,000 would see their incomes go up over 20 percent.