And that brings us to today’s dilemma. Precisely because Reagan’s reforms brought tax rates down so much in the 1980s, U.S. tax rates remain historically low. Hence, marginal gains from future tax reform will never be as great. But that doesn’t mean the Bush administration can’t do better than what the tax panel is proposing.
In putting together its ultimate reform proposal, the White House could leave the AMT in place, but index it to both inflation and wage gains. In this way the tax will not affect Red State middle-income taxpayers, and will simply impact the very top earners everywhere, including the Blue State rich folk. More, this adjustment will make room for deeper income-tax cuts, say to a top rate of 25 percent with perhaps one more bracket at 15 percent.
At a 25 percent top rate, successful earners would keep 75 cents on the extra dollar, a 15 percent improvement over their current plight. This rate would allow for simplification and reduced mortgage deductions, while keeping the state and local deduction in place.
Sources tell me that House Ways and Means chair Bill Thomas is looking at just this kind of trade-off. With this in place, key investment tax rates could be set at 15 percent for capital gains, dividends, and inheritance taxes. (It’s the after-tax yield on investment that provides the seed corn for job-creating new businesses.) The top corporate tax rate, now pegged at 30 percent by the tax panel, could also be brought down to 25 percent. And corporate capital-gains taxes could be eliminated, further reducing the multiple-taxation of capital.
A 10 percentage-point drop in tax rates for individuals and businesses would be a political eye opener and one worth fighting for. In effect, the purity test would fail, but the economic growth test would succeed. Three-quarters of a loaf of tax reform is better than no loaf at all if economic growth over the next twenty years increases as much as 5 to 7 percent. That’s real money, along with bucketfuls of new jobs and prosperity.