As Donald Trump and Ted Cruz battle to become the Republican nominee for president, it is time to closely consider their policies. Although both propose cutting taxes, the details of their plans are very different. Ted Cruz is proposing a drastic revision of the tax code that would replace the progressive income tax with a flat tax. Donald Trump’s proposal, though it would lower the top tax rate, preserves higher rates on the rich. In terms of sound principles that should guide discussions of future tax policy, Cruz’s proposal is better than Trump’s.
Cruz’s plan, which includes a 10-percent flat-tax rate on income and a value-added tax to replace the payroll tax, would reduce overall taxes paid by almost everyone. He proposes repealing the corporate-income tax, the payroll tax, estate taxes, and gift taxes and replacing those taxes with a 16-percent value-added tax. By altering incentives to work and save his plan could have a large positive effect on economic growth.
Trump’s plan would also lower tax rates for most Americans, reducing top tax rates to 25 percent. Trump proposes a flat corporate-income tax rate of 15 percent and would also repeal federal estate and gift taxes. It would not change the payroll tax, which is used to fund Social Security and Medicare.
Trump’s plan would reduce government revenue by more than Cruz’s plan. It cuts middle-class taxes by more but reduces rates less for those with high incomes. The Tax Policy Center estimates that Cruz’s plan would reduce revenue by $8.6 trillion over 10 years, while Trump’s would reduce revenue by $9.5 trillion over ten years.
Cruz’s tax plan also has some other positive features that are worth noting. It effectively exempts savings and investment income of the middle class from taxation. This incentivizes greater savings and investment, which are important for promoting economic growth.
Because each plan substantially reduces the amount of revenue collected by the federal government, it would raise the federal deficit unless Congress has the political will to enact similarly large spending cuts. The Tax Policy Center estimates that by 2025, the annual reduction in revenue from either plan would exceed the entire military budget.
Both candidates’ plans are consistent with the view that people can make better decisions than the government about how to spend their own money. Both also are based on the premise that lower tax rates on the rich increase their incentives to save, invest, and create business. But in proposing a flat tax, Cruz goes one step further than Trump. With his plan, the wealthy get to keep the same percentage of each additional dollar they earn by working harder, as do the middle class. Those with more income would pay proportionally more, but would have the same incentive as everyone else to earn more.
The Tax Policy Center may be overestimating the revenue lost from each plan because it fails to account for all the ways that lower tax rates increase incentives to work longer hours, take risks, and start businesses. These effects will be particularly pronounced for high-income earners, who are the most capable of starting businesses and investing in business expansions that can lead to more employment opportunities for low- and middle-income workers. By promoting faster economic growth, tax cuts may increase the amount of income earned before taxes, partially offsetting some of the revenue lost due to lower tax rates. Tax cuts are more likely to promote growth if they are financed by cuts in government spending rather than by increases in the deficit.
The problem with past cuts in federal income-tax rates, such as those implemented by Presidents Reagan and George W. Bush, was that they were not accompanied by comparable reductions in spending. If spending is not reduced by the same amount as revenue is reduced, tax cuts may do more harm than good. It is much easier for a candidate to propose large tax cuts than it is for Congress to enact even modest cuts in federal spending.
Of the two proposals, Cruz’s is better because it is simpler and because it treats additional income earned by the wealthy the same way as income earned by everyone else. Either Cruz’s or Trump’s plan would improve incentives by reducing personal income-tax rates and reducing or eliminating the corporate-income tax, which is much higher in the United States than in other countries. If one of them is elected, the large tax cuts he is proposing should only be implemented if Congress approves drastic cuts in spending. Otherwise, we won’t have to wait very long before the federal government can no longer pay the Medicare bills and send out the Social Security checks it has promised.
Cruz’s plan is the preferable of the two, particularly if it is used as a starting point for a discussion about principles to consider in fixing the federal government. But cutting spending also needs to be a part of that discussion.