Mises Wire

Beware “Revenue Neutral” Tax Reform

Whenever politicians bring up the topic of “tax reform,” what they usually want is a reshuffling of taxes so changes to the tax code will look like a tax cut — without reducing tax revenues or lessening the tax burden. In other words, policymakers usually want a tax reform that is “revenue-neutral,” and this has been explicitly stated by lawmakers on both sides of the aisle for years now. 

Last month, for example, Kevin Brady, the chairman of the House Ways and Means Committee stated through his office that he will propose a new tax plan to Donald Trump that will not cut tax revenues: “rather than reducing tax revenue and increasing the US fiscal deficit, will ‘break even within the budget, knowing it’s going to grow the economy.’”

This is standard operating procedure in Washington, and was also the case with the 1986 tax reform under Reagan.

From the perspective of the policymakers, revenue-neutral tax reform is a good thing because it allows them to reward interest groups the party in power likes, while punishing the interest groups they don’t like. That is, reform allows them to to pick winners and losers in the newly-rearranged tax situation. In many cases, tax reform also allows policymakers to make claims of “tax cuts” to groups of voters without actually cutting government revenues, and thus continuing to spend freely. 

With a newly invigorated Republican-controlled Congress in DC, we’re looking at a spate of new tax reforms. Among the proposed reforms are changes to the home mortgage interest deduction and the elimination of the deduction for state and local taxes. 

Right now, the debate over tax reform continues to be speculative and technical in nature, but some specifics are appearing. For example, as noted by Hugh Hewitt in the Wall Street Journal

The day after President-elect Trump announced Steven Mnuchin’s nomination, the Treasury secretary-designate casually declared on CNBC that the administration’s plan would “cap mortgage interest, but allow some deductibility.” In other words, Mnuchin wants to change how much tax revenue is inhibited by the deduction. 

The GOP, including House Speaker Paul Ryan, has already jumped on the bandwagon with new proposals to modify the deduction. In typical tax-reform fashion, this is being framed as a change that will benefit some groups (middle-income homeowners) at the expense of others.

Also out the window, we are told, is the deduction for state and local taxes, which itself also tends to be utilized by higher-income earners.

These reforms are being promoted as changes that will hurt “the wealthy” but help middle-class taxpayers. But, since we dare not reduce government revenues — the thinking goes — any tax reform must involve raising net taxes somewhere to make up for any reduction in net taxes anywhere else. 

There are at least two problems with this approach:

  • Raising the burden on “the rich” does not necessarily help middle-class taxpayers. 
  • The spending phase of tax revenue is just as damaging as the collection phase. 

First of all, it is not at all clear that an ordinary taxpayer benefits from a tax increase on the so-called wealthy. The wealthy, after all, are generally not people who could be called “the idle rich,” not are they absentee plantation owners as imagined in romantic books about the days of yore.

Most of the “wealthy,” as envisioned by federal policy, are simply people who make $200,000 per year or more and are business owners, managers, investors, and property owners. They are people who hire other people, perform upkeep on apartment buildings, and inject loanable funds into the banking system. 

By sticking it to “the rich” with tax reform, this only serves to reduce the amount of money available for hiring new employees, expanding businesses, and improving upkeep on capital. It means fewer loanable funds in banks and fewer investors available to put money into small businesses and public companies. 

Thus, if a tax cut as part of tax reform package requires a tax increase on someone else, this in no way should be interpreted as necessarily helping the more middle-income taxpayers. Yes, it helps those who work federal jobs, receive government welfare, and make money off government contracts. But, a great many people not lucky enough to receive these benefits will be hurt by taxes on the rich in the form of lost job opportunities, higher-priced goods, and less access to bank loans. 

The Problem With Government Spending 

Our second problem stems from the fact that the spending phase of the tax-and-spend process is just as damaging as the collection phase. 

In Man, Economy, and State, Murray Rothbard explained the error of focusing on taxes while ignoring government spending (p. 910):

There has also been a great amount of useless controversy about which activity of government imposes the burden on the private sector: taxation or government spending. It is actually futile to separate them, since they are both stages in the same process of burden and redistribution...

[S]suppose the government taxes the betel-nut industry one million dollars in order to buy paper for government bureaus. One million dollars’ worth of resources are shifted from betel nuts to paper. This is done in two stages, a sort of one-two punch at the free market: first, the betel-nut industry is made poorer by taking away its money; then, the government uses this money to take paper out of the market for its own use, thus extracting resources in the second stage. Both sides of the process are a burden. In a sense, the betel-nut industry is compelled to pay for the extraction of paper from society; at least, it bears the immediate brunt of payment. However, even without yet considering the “partial equilibrium” problem of how or whether such taxes are “shifted” by the betel-nut industry onto other shoulders, we should also note that it is not the only one to pay; the consumers of paper certainly pay by finding paper prices raised to them.

Thus, when the focus of tax reform is simply re-arranging the winners and losers without engaging the issue of revenues and spending, the net effect on the general economy will prove to be nothing positive at all. 

A Good First Step In Reducing the Burden of Government 

If Congress were really serious about eliminating one of the largest burdens on taxpayers, it would simply strive to eliminate the budget deficit rather than talk up yet another futile tax reform package. After all, one of the most burdensome and regressive taxes is the inflation tax resulting from money creation employed to fund deficit spending. Rothbard continues: 

When taxes are less than government expenditures (and omitting borrowing from the public for the time being), the government creates new money. It is obvious here that government expenditures are the main burden, since this higher amount of resources is being siphoned off. In fact, as we shall see later when considering the binary intervention of inflation, creating new money is, anyway, a form of taxation. [emphasis added.]

As we’ve noted before, there’s almost no chance at all that the leaders of the GOP will seriously approach the issue of government spending. As usual, there is almost no political will to cut spending on Capital Hill, which is why tax revenues must never be cut. From Washington’s perspective, any tax reform package must not get in the way of keeping the federal government flush with taxpayer cash. 

Image Source: Rep. Kevin Brady via Brookings Inst. www.flickr.com/photos/96739999@N05/
Note: The views expressed on Mises.org are not necessarily those of the Mises Institute.
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