August 24, 2004

Making Sense of the Bush, Kerry Tax Plans

(This articled appeared in the Providence Journal August 24, 2004)

IF TAXES are the price of civilization, election year is the time for bargain-hunting. Over the last few months, President Bush and Sen. Kerry have presented their tax plans to voters, and have mostly gotten blank stares in return.

Presidential tax plans are notoriously dense, with sound bites and boring jargon obscuring their impact. For those of us who aren’t tax lawyers and accountants, how should we choose between tax plans this November?

One way is to ask the common sense question, “What makes a good tax?” and then compare plans to that ideal. Thankfully, economists over the years from Adam Smith to Milton Friedman have done this for us, and have boiled down their tax wisdom into five simple rules:

  • Simplicity: Taxes should be easy to understand, and easy to pay.
  • Transparency: Taxpayers need to know the cost of government in a democracy. Taxes shouldn’t be hidden or misleading in their impact.
  • Stability: Good economic decisions require stable “rules of the game.” Tax law shouldn’t change continually or apply retroactively.
  • Neutrality: Taxes should aim to raise revenue without economic distortion, and shouldn’t attempt to “socially engineer” the economy.
  • Growth-friendliness: Taxes should consume as small a part of national income as possible, and shouldn’t interfere with trade or capital flows.

The Bush and Kerry plans present two very different visions for America’s tax code. The centerpiece of the Bush plan would make the 2001 and 2003 tax cuts permanent, including the $1,000 child tax credit, reduced “marriage penalty,” cuts in the tax rates on dividends and capital gains, and phasing-out the “death tax.” The Kerry plan would let many of the Bush cuts expire, and replace them with an assortment of tax credits and penalties aimed at changing taxpayer behavior.

So how do they compare to the rules?

Regarding simplicity, both plans are equally lousy. Neither streamlines the tax code and regulations — now at 60,000 pages and growing. Neither reforms the alternative minimum tax (AMT) — the convoluted add-on tax that threatens to hit 30 million households by 2010. And despite rumors of a possible flat tax or national sales tax if Bush is reelected, the official Bush plan includes little simplification. Instead, both plans pile onto the mind-blowing complexity of the current tax code.

On transparency, the Bush plan wins by a nose. Though it’s murky in parts, it relies on simple across-the-board rate cuts. The Kerry plan — true to his “hope is on the way” campaign mantra — unleashes a torrent of targeted tax breaks and penalties for preferred behaviors, ranging from tax incentives for “green” construction to credits for rural Internet service providers.

The Bush plan wins stability points by making permanent the temporary 2001 and 2003 tax cuts, although the current mess of advancing and retreating on temporary tax cuts is a Bush administration blunder to begin with. As for the Kerry plan, which would revive the “death tax,” let the Bush tax cuts expire, repeal the cuts in top rates, and introduce new temporary tax goodies for politically favored groups — the only thing stable is the income that it will generate for tax accountants.

The Kerry plan is loaded with temporary tweaks of the tax code, making America’s tax code less stable and predictable.

How about neutrality? Again, the Kerry plan’s mélange of carrot-and-stick tax credits clearly violates the “no social-engineering” rule. Although the Bush plan also violates the rule with targeted tax cuts, such as the child tax credit, it also reduces discrimination in the tax code with top-tax-rate cuts and a flat 15 percent rate on capital gains and dividend income.

In the long run, the last rule of “growth-friendliness” matters most. Taxes that kill the goose kill the gold. Which plan is better on economic growth?

To its credit, the Kerry plan would cut the corporate tax rate, and that makes U.S. companies more competitive globally. However, it also penalizes global U.S. companies in an attempt to curb “outsourcing,” potentially harming U.S. workers in those industries. Also, it hikes taxes on $200,000-plus earners, which promises to hurt job growth since many of those taxpayers are job-creating business owners.

In contrast, the overriding theme of the Bush plan is growth-promotion through across-the-board rate cuts and better expensing rules for small business. Some parts of the plan ignore growth, such as the child tax credit, which is good for families but won’t boost growth much, but overall the Bush plan clears the path for economic expansion.

The bottom line? The Bush and Kerry plans offer starkly different visions for the future of the tax code. Unfortunately, unless the president calls for dramatic tax reform in his Republican National Convention address next week, neither candidate has outlined any concrete plan for the fundamental tax reform America needs today.

Andrew Chamberlain is a staff economist at the Tax Foundation.