There is widespread agreement that the tax code is inhibiting economic growth and harming American families as a result.
Rep. Chris Van Hollen, D-Md., ranking member of the House Budget Committee, acknowledges that fact with the release of a plan he argues would help the middle class. As with all proposals, the devil lies in the details. Examination of them shows his plan to be lacking.
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The tax code is an albatross around the neck of the economy because it creates sizable disincentives for engaging in the activities that are the building blocks of economic growth (working, saving, investing, and taking risk) by applying high rates on all of them.
Van Hollen would give middle class taxpayers a $1,000 per worker tax credit, create an incentive to put a portion of that money in 401(k)-like retirement plans, provide a deduction for a portion of a second-earners income and increase the Child and Dependent Care Credit. He would also try to compel businesses to pay more to their employees by limiting the deductibility of their CEO’s compensation.
The families that benefit from these policies would certainly like the extra money they would directly see in their pockets. However, those benefits would be greatly tempered by the taxes Van Hollen would raise to pay for the cuts. He would raise taxes on high-earners by limiting their tax preferences (details to come later) and levying a financial transactions tax.
Without knowing exactly how Van Hollen would curtail tax preferences, it is not possible to determine how large the policy’s negative impact would be, but tax increases undoubtedly hurt growth. The financial transactions tax would hurt economic growth also, and shrink the size of everyone’s retirement plans, including the middle class.
Van Hollen’s tax hike pay-fors would hurt growth, while his middle class tax cuts would do nothing to stimulate growth.
Tax cuts only spur growth when they reduce marginal rates or reduce the bias against savings and investment. In other words, they are only pro-growth if they improve the incentive to work, save, invest or take entrepreneurial risk.
Van Hollen’s new deductions and credits do not to reduce disincentives for productive activities. Ultimately, the plan leaves the economy worse off than it was before, while temporarily giving the impression that it fixes the fundamental problems with the tax code.
One of the goals of Van Hollen’s plan is to reduce income inequality. The additional money in the pockets of middle-class taxpayer may initially give the appearance of achieving that goal. However, when all the effects of the plan are taken into account, the benefits are lessened greatly, and perhaps wiped out entirely. In addition, there will be less economic vibrancy and reduced opportunity for Americans at all income levels.
A better way to help the middle class is through fundamental tax reform that would increase growth by reducing marginal tax rates. The renewed growth will enhance the incomes of all Americans, instead of picking winners and losers like the Van Hollen plan would.
