This content is provided by Americans for Tax Reform Foundation.
With the United States mired in the weakest recovery in decades, President Obama wants to raise marginal income tax rates on working Americans. Governor Romney, on the other hand, understands the profound negative consequences of high marginal income tax rates. For this reason, Romney has proposed a permanent 20 percent across-the-board cut in marginal income tax rates: taxpayers in all five income brackets, from those who pay the top rate of 35 percent to those with the lowest marginal rate of 10 percent, would see their taxes reduced on the next dollar of income they earn under Governor Romney’s plan.
Basic economic theory dictates that when individual income tax rates are reduced, workers will supply more labor and increase their production. As a result, the economy expands and jobs are created. The data are largely consistent with this explanation.
One important piece of evidence on the subject of the benefits of income tax cuts is a paper co-authored by two Treasury Department economists entitled “Income Taxes and Entrepreneurs’ Use of Labor.” That paper found that a marginal rate cut of 10 percent increased the probability of hiring by approximately 12 percent.
In addition to boosting hiring, a decrease in marginal income tax rates has also been shown to help firms grow financially. A marginal rate cut of 10 percent was found to increase receipts for sole proprietors by 8.4 percent.
The permanent nature of the individual income tax rate will also aid in eliminating the job-killing uncertainty surrounding the future of American tax policy. Ambiguity with regard to the tax system has risen to a historically high level in recent years, as Congress has battled over extending current rates and settled on short-term extensions.
According to a 2011 study by economists at the University of Chicago and Stanford University, uncertainty led to a 1.4 percent reduction in GDP in that year. Moreover, the authors found that returning uncertainty to its level prior to the 2008 financial crisis would create 2.3 million new jobs in just a year and a half. While a permanent reduction in marginal income tax rates would be unlikely to return uncertainty to pre-crisis levels, it would certainly make a major impact.
While the proposed 20 percent across-the-board reduction in marginal income tax rates is an important step, it is best viewed as part of a larger goal: structural, pro-growth tax reform. The essential components of such a plan include the transition to a territorial system, the elimination of investment disincentives, and the phasing out of many subsidies.
Under Governor Romney’s proposal to reform the individual income tax system, the top rate would be set at 28%, which is the same rate that was instituted when President Reagan signed tax reform legislation in 1986. Reagan knew something about tax policy: his pro-growth reforms led to a strong recovery from a deep recession and a period of sustained growth. Governor Romney’s plan, which echoes the legacy of President Reagan, is the right plan for America’s future.