As the political and media classes ponder the fiscal cliff, many are tempted to pigeonhole conservatives into a box that says they are either against all types of tax revenue or open to all types of tax hikes. That is a completely false choice.
When considering a tax code that is 70,000 pages long, and a federal budget that contains nearly $4 trillion in annual spending, it is clear that not all taxes or revenue generators are created equally. The media’s fixation on pledges misses the point. The standard by which we should measure legislation is not whether it generates revenue. Instead, the paramount consideration should be whether it promotes economic growth.
As a general matter, higher taxes and bigger government are detrimental to economic growth. But generalities are not always informative. For example, last year the Club for Growth supported legislation by Oklahoma GOP Sen. Tom Coburn that would have eliminated the ethanol tax credit. That measure contained no countervailing reduction in tax rates or spending and it would have generated additional revenue to the federal treasury. However, the ethanol tax credit is such an egregious market distortion that its removal is pro-growth, notwithstanding the federal revenue increase.
The tax code is chock full of market-distorting subsidies, loopholes and social engineering incentives. The government’s promotion of the misallocation of capital is decidedly harmful to economic growth. Conservatives wisely opposed many of them before they were enacted. Yet some adopt the warped logic that once these boondoggles make their way into the tax code, they must be kept there, because eliminating any of them is somehow tantamount to raising taxes. In fact, some of these provisions are functionally no different from spending programs, and they ought to be eliminated.
The same principle applies to revenue. While the Bowles-Simpson proposal contained some very anti-growth provisions, it also embraced the proposition that a tax overhaul that eliminates deductions and lowers rather than raises income tax rates is pro-growth, and thereby also increases revenue. Sen. Patrick J. Toomey, R-Pa., correctly captured this principle in last year’s Joint Select Committee on Deficit Reduction with his proposal that would have lowered rates, limited deductions and raised revenue.
That brings us to the current debate and the question of how tax revenue might be increased without harming the economy.
President Barack Obama appears determined to inflict the worst kinds of anti-growth changes on the tax code, raising rates on income and investment. Those should be strenuously opposed. Speaker John A. Boehner, R-Ohio, and others rightly counter that revenue increases can be achieved through reducing deductions that do not have the same negative consequences for our economy.
We agree, but again, the economic growth comes if the elimination of deductions is accompanied by lower marginal rates. Alan K. Simpson and Erskine Bowles recognized this when they advocated cutting the top marginal rate to between 23 percent and 29 percent, not increasing it to nearly 40 percent as Obama would do. The serious flaw in Boehner’s current proposal is that it contains no pro-growth rate reductions.