An exciting presidential race has brought attention to 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. policy, and frequently, to Tax Foundation’s analysis of candidate plans. The three most popular candidates in the Republican race have all put together tax reform proposals.
Tax cuts can increase the size of the economy by improving incentives to work or invest. To some extent, all three candidates’ proposals do this, and our modeling results for each plan show growth. But our model shows more growth from the Rubio and Cruz plans than the Trump plan, even though Trump proposed a larger cut:
Some of our readers may be curious why some tax cuts generate more growth than others. The answer is pretty simple. While Donald Trump largely opted for big rate reductions across the board, Rubio and Cruz made improvements to the structure of taxes, while cutting taxes by less overall. In this, they got more bang for their buck. I’ll highlight one particular example here.
Senators Rubio and Cruz both put thought into the nature of the taxes that businesses pay. They noticed that the current way businesses are asked to calculate taxes creates a bias in the code. When a business builds something new, like, say, a new industrial lathe, that decision actually has a higher tax burden, on net, than simply disbursing the money to shareholders. That’s bad news for machinists, who would much rather that they had new and better tools with which to do their jobs.
Rubio (through modifications of the corporate income taxA corporate income tax (CIT) is levied by federal and state governments on business profits. Many companies are not subject to the CIT because they are taxed as pass-through businesses, with income reportable under the individual income tax. ) and Cruz (through the total conversion of corporate income taxes to his business 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. ) both fix this problem by making the full amount of money spent on the lathe deductible from taxable incomeTaxable income is the amount of income subject to tax, after deductions and exemptions. For both individuals and corporations, taxable income differs from—and is less than—gross income. . And of course, this applies not just to lathes but to all other kinds of capital investments that businesses purchase: things like buildings or pile drivers or trucks or oil rigs. I write about the cleverness of this policy in Marco Rubio’s plan here, though it applies equally to Ted Cruz’s plan.
In contrast, Trump did little to change the domestic corporate tax system, and merely lowered its rate. This policy has its benefits, including the benefit of growth, but it substantially reduces revenue.
There are, of course, other things in play besides this particular provision. But it’s a good example of a broader trend: the senators pay attention to the details of the tax baseThe tax base is the total amount of income, property, assets, consumption, transactions, or other economic activity subject to taxation by a tax authority. A narrow tax base is non-neutral and inefficient. A broad tax base reduces tax administration costs and allows more revenue to be raised at lower rates. , and try to fix incentive problems that the tax base creates. Mr. Trump mostly lowered rates.
Our model notices distinctions like this, and observes the incentives that different tax systems create. America under the Marco Rubio or Ted Cruz tax plan would simply have more lathes and buildings and trucks, and people would be more productive and have higher incomes because of it. And this is not because they propose fewer taxes, but rather, because they propose taxes with better bases.
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