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Rubio-Lee Tax Plan Gets Thumbs Up From Tax Foundation

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It takes money to make money, goes the old adage—and while that saying is usually applied at the level of individual businesses, it could be fairly used to describe the economic effects of the Rubio-Lee tax reform plan, according to an analysis by the Tax Foundation.

Sens. Marco Rubio, R-Fla., and Mike Lee, R-Utah, the former a potential 2016 presidential candidate, introduced their sweeping tax reform proposal last week, and the measure has already received a fair amount of criticism.

A New York Times editorial derisively dubs it the Puppies and Rainbows Tax Plan, saying “it’s full of things everybody likes, at least on the Republican side: family tax cuts that will make it easier to buy the children a puppy, and capital tax cuts that chase a pot of capital investment gold at the end of the rainbow.”

In short, the criticism is that Rubio-Lee would cost the government trillions it cannot afford.

The Tax Foundation, a nonprofit, nonpartisan research foundation that advocates for broad-based, low-rate, simple and transparent tax rules, acknowledges the plan would increase the U.S. budget deficit by over $2 trillion (including added debt-servicing costs) during the initial 10-year budget window.

But the authors of the analysis, Tax Foundation senior fellow Michael Schuyler and chief economist William McBride, emphasize that the proposal’s long-term impact would be to increase the size of the economy by over 15%, contributing an extra 1.44% annually to the currently projected GDP growth rate.

Thus, the Tax Foundation analysts distinguish between a “static” model that ignores the impact that tax changes have on economic growth and a “dynamic” model that accounts for such tax-induced changes in economic activity.

Based on their dynamic modeling, Schuyler and McBride write that “the Rubio-Lee plan would grow the economy, and the size of the economic pie is a major determinant of tax collections. In fact, some of the changes are so strongly pro-growth…that the model predicts the plan would increase federal revenue by over $90 billion annually in the long run.”

The proposal has three key features, not all of them mutually consistent from an economic perspective.

The first key thrust is the plan’s $2,500 child tax credit — the “Puppies” part of the plan in the Times’ telling.

Rubio and Lee adopt this costly provision because they want the tax code to “better reflect the costs of raising children,” the authors write, though the economists add that their model is unable to quantify such social benefits.

From an economic viewpoint, Schuyler and McBride argue that Rubio-Lee eliminates biases against savings and investment, particularly through reducing taxes on business income (both corporate and non-corporate) to a maximum of 25%; allowing immediate (rather than gradual) write-offs on equipment, intellectual property, inventory and other business investments; and eliminating the tax on capital gains and dividends. The proposal tweaks the code in many other ways as well — from an elimination of the estate tax to repeal of Obamacare surtaxes.

Moreover, the proposal simplifies the tax code, mainly through the adoption of a two-rate tax structure (15% and 35%), with the latter’s joint-income threshold at exactly twice the individual rate ($150,000 and $75,000) so as to avoid a marriage penalty.

Rubio-Lee further simplifies the code by eliminating all itemized deductions except for charity and mortgage interest, though it significantly trims deductions allowed for the latter. The plan also abolishes the alternative minimum tax.

The plan has many other features which the economists detail, but the thrust of their analysis lies in their modeling of its overall effects, which is to spur a higher level of sustained prosperity through increased incentives to work, save and invest.

Specifically, the Tax Foundation analysts say the plan would produce 15% higher GDP, or $2.7 trillion annually in 2015 GDP terms; increase investment in plants and equipment by 50%; boost the labor force by 2.7 million jobs; and raise hourly wages by 12.5%.

But making all this money takes money — and the cost to federal revenue amounts to $414 billion annually.

At current GDP levels, such revenue losses would increase federal debt by $2.3 trillion in the first 10 years, but future revenues would start subtracting from the debt by around 2040.

At the individual level, the Tax Foundation analysts find that Rubio-Lee would boost after-tax income at all levels — by 56% for the lowest 10% of earners, 23% for the 10%-20% decile, 15.3% for the 50%-60% decile and 19.9% for the 90%-100% decile. On average, Americans would see their incomes rise by about 18%.

— Check out Top 7 Income Sources in America on ThinkAdvisor.