Why Marco Rubio’s Tax Plan Might Stick Around

March 16, 2016

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 tax 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 tax, or flat tax would).

Rubio's plan would have pretty much eliminated the current tax code's bias against saving and investment with three significant changes:

  • Full expensing 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 rate on corporate income from 35 percent to 25 percent, eliminated the estate and gift tax, moved to a territorial tax system, 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 deduction and personal exemption with a per-filer refundable tax credit of $2,000 and by enacting a new $2,500 refundable child tax credit. 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 businesses. 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.

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