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Financial Planning > Tax Planning > Tax Reform

Republicans Need a Tax Plan for 2017, Not 1981

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It’s not 1981 anymore. That’s the message of an editorial in the conservative Weekly Standard, which warns Republicans not to design a tax reform patterned on the one that Ronald Reagan signed in his first year as president.

Mimicking the Reagan tax cuts is a temptation both because of Republicans’ enduring admiration for the 40th president and because his program has been the source of the economic ideas they have championed ever since his time in office.

But the Standard is right that times have changed. That doesn’t mean the Gipper’s basic disposition toward lower and less onerous taxes needs to be junked. It means that today’s Republicans (and Democrats!) need to grapple with four differences between our time and his.

First: The federal debt is much larger now, and looks to grow larger still. When Reagan took office, that debt stood at 31% of GDP. It’s now about 103%. The Baby Boomers were still entering the workforce then. Now that they are leaving it, the debt picture we can anticipate is much worse.

Reaganites would have preferred it if spending restraint had accompanied tax cuts, but they were willing to accept rising deficits rather than give up those tax cuts. That trade-off looks worse in our current fiscal position.

Second: The top individual income tax rate is a lot lower than it was in 1981. Reagan inherited a tax code with a top rate of 70%. His tax legislation lowered it to 50%, and by the time he left office he brought it down to 28%. It is now roughly 40%.

Supply-siders argue that reducing tax rates increases incentives to work, save and invest. But this logic is subject to diminishing returns. The 1981 bill raised the after-tax return on a dollar earned from 30 cents to 50 cents: a 67% increase. Cutting the top tax rate from 40 to 30% now would yield an increase of only 17%.

Another way of putting it is that today’s tax rates aren’t the obstacle to growth that the rates of the 1970s were. Bringing them down should not be as high a priority for today’s Republicans as it was for their predecessors.

Third: The payroll tax for Social Security and Medicare has grown in importance while the income tax has shrunk. In 1981, only 20% of households escaped paying the income tax. Now 44% do. For three-fifths of households, the payroll tax is a bigger burden than the income tax. If Republicans want to provide relief for the middle class, they should be looking at reducing payroll taxes and not just cutting income-tax rates as they did in 1981. One option would be to apply an expanded child credit against payroll taxes.

Fourth: The corporate tax rate has become a bigger problem. It has fallen since 1981, from 46% to 35%. But other countries have cut their rates further. In 1981, the corporate tax rates for Germany, the U.K. and Ireland were 56, 52 and 45, respectively. Now they are 39, 19 and 12.5. The U.S. corporate tax has made the country a less attractive place to invest, and rectifying that problem should be a priority for modern tax reform.

To their credit, Republicans are dealing with some of these new realities. They’re giving more attention to cutting the corporate tax rate than cutting the top income-tax rate. But it remains to be seen how much they are willing to change. The old reflexes are still strong, even if they were adapted for an environment we no longer inhabit.


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