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Tax Reform Proposals Distract from the Real Issue: Reining in Government Spending

October 27, 2011
Historical government spending in the United S...

This past Tuesday, Rick Perry unveiled his tax reform proposal in an effort to regain some of the momentum his campaign has lost in recent weeks. It is the second such plan to come from a Republican candidate, joining Herman Cain‘s much discussed 9-9-9 plan.

Perry’s flat tax proposal would drastically change the current tax system, with the main component being the choice between a flat tax rate of 20% or their  rate in the current system. The new flat tax  would preserve mortgage interest, charitable and state and local tax exemptions for families earning less than $500,000 annually, and it increase the standard deduction to $12,500 for individuals and dependents.

So far, reactions have been mixed. Grover Norquist and the Wall Street Journal reacted favorably to the proposal, while the National Review was less enthused.

There are aspects of the plan that are appealing: there is a pretty wide consensus that the current tax code is overly complex, and has too many loopholes and exemptions that distort economic decisions.

Like Cain’s plan, Perry’s loses some of its seductive simplicity upon closer scrutiny.

One thing that is certain, the plan has reinvigorated a fading Perry, unleashing a deluge of much-needed media exposure, and doing something to address the oft-heard critique that he was light on policy specifics.

The most troubling aspect of this tax reform is not even directly related to the proposed changes to the tax code. It is the same specter that haunts Herman Cain’s 9-9-9 plan. Both candidates, in introducing their dramatic proposals that would overhaul the much-maligned tax code, have shied away from making any serious or specific proposals to rein in government spending.

Over the past 50 years, the marginal tax rates have fluctuated, from a top marginal tax rate of 91% as late as 1963, to the current top rate of 35%. In all that time, current recession excluded, tax revenues have fluctuated around 18% of GDP, showing little responsiveness in changes to the tax rates.

While both of these proposals would throw out the tax rate, and conceivably raise higher revenues, most analyses of the two proposals show them raising significantly less, raising questions as to how the two candidates would carry out their proposals without raising the already burdensome annual budget deficit.

All of this serves only to distract from the real issue, which is not the tax system, inefficient as it might be. but spending. Federal spending in 2011 will be around 24% of GDP, and the Congressional Budget Office generously projects that it will stay in this 23-24% of GDP range for the next decade, although the recent trend in government spending since Clinton suggest it is far more likely that the percentage will continue its steady march upwards unless serious steps are taken to rein it in.

It remains unclear what steps the any of the aspiring candidates would take to address this monumental gap between the historic 18% revenue and current 24% spending, and it is not hard to see that a recurring annual deficit of 6% is in no way sustainable, especially with the high level of debt the US is already facing.

Perry at least acknowledges the issue of runaway government spending, albeit he does not propose anything definitive or specific, saying only that his plan will seek:

a clear goal of balancing the budget by 2020. But that growth is what will get us to balance, if we are willing to make the hard decisions of cutting… We should start moving toward fiscal responsibility by capping federal spending at 18% of our gross domestic product, banning earmarks and future bailouts, and passing a Balanced Budget Amendment to the Constitution

While it is a positive sign that he seems to recognize that controlling government spending, and that there will be hard decisions in terms of cuts, but he unsurprisingly demurs from making any of these hard decisions in his plan.

Milton Friedman concisely articulated the correct response to tax reform proposals, explaining that while the intent of these reform was admirable, and often they had good content: 

the big problem is not taxes, the big problem is spending. The question is, “How do you hold down government spending?”

Unfortunately, at least for now, we will all have to wait to find out the answer.

 

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