The Big Six —two representatives each from the White House, the Senate and the House of Representatives — released their framework for tax reform on Wednesday and the responses have been lukewarm to negative. A particularly brutal take came from Josh Barro at Business Insider, who called the GOP’s pledge to “double the standard deduction” a lie.

Here’s the important fine print: “To simplify the tax rules, the additional standard deduction and the personal exemptions for taxpayer and spouse are consolidated into this larger standard deduction.”
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If you have children, your fate is uncertain. The plan would abolish the $4,050 exemption you get to take for each of your dependent children. But it would also increase the child tax credit—by an unspecified amount. Once that amount is specified, you’ll be able to figure out whether you face a tax increase or a tax cut or what.

Indeed, Barro is right. The released framework suggests, but doesn’t guarantee an actual reduction in taxes for middle- and lower-income taxpayers. Furthermore, I agree with my colleague Sam Hammond that the most promising way to provide relief for middle-and lower-income families is a large refundable increase in the child tax credit.

Yet, while this proposal isn’t as promising as it could be in terms of tax relief, it scores better as tax reform. For individual taxpayers, we see a meaningful effort to curb and slowly eliminate the myriad of deductions and loopholes that plague the tax code. On the corporate side, the move to a territorial system is a step in the right direction, toward a system with less gamesmanship and fewer tax-avoidance strategies.

That being said, I understand the incredulity and disgust provoked by the administration’s rhetoric. President Donald Trump explicitly rejected the tax reform label in favor of the more compelling, but far less accurate, language of a middle-class tax cut. We shouldn’t, however, let the president’s inanity drive our actual analysis of policy. If we do that, the imps win. Secretary of State Rex Tillerson said it best: “The president speaks for himself.”

There are two big elements in this package that tax reformers have been looking for—for decades. The first is an end to itemization in the individual tax code. The second is the move to destination-based taxation in the corporate code.

Individual Tax Reform

The tax reform framework calls for collapsing the personal exemptions in the current tax code into a new, larger standard deduction. In the current tax system, virtually all taxpayers get to claim a personal exemption for each member of their household. Then on top of that, taxpayers get to choose to either itemize the rest of their deductions or take the standard deduction. About 70 percent of taxpayers choose the standard deduction. The 30 percent who choose to itemize are often wealthier households, who do so to take advantage of the home mortgage interest deduction, the charitable deduction or the deduction for state and local taxes.

Sweeping the personal exemption into a larger standard deduction has a few effects. First, it increases the amount of income someone can make before they owe any taxes at all.

One of the more unfortunate aspects of the 2012 presidential campaign was the rise of the “I am the 53 percent” movement. The movement’s name stemmed from Republican nominee Mitt Romney’s comment that 47percent of Americans pay no income tax at all and its central complaint was that the other 53 percent of Americans who did pay income tax were shouldering the burden of their indolent compatriots.

In truth all Americans—in their roles as workers, owners or simply consumers—bear the burden of taxes whether they write a check to the government or not. Taxes distort and typically reduce the size of the economy in ways that affect everyone.

The most distortionary effects, however, come at the extensive margin. That refers to the decision to work or invest at all. For this reason, taking as many low-income workers off the tax rolls completely has been a goal of tax reform going back to 1981. We’d like the tax system to encourage or, at a minimum, not discourage folks from entering the labor market and developing skills. For families with children this means the Earned Income Tax Credit. For young single people with few skills, this means taking as many off the tax rolls as possible.

Second, sweeping the personal exemptions into the standard deduction makes itemizing far less attractive. Now, a family considering itemizing would have to find at least $24,000 worth of deductions to make it worthwhile. For most itemizers, the largest deduction is the one for home mortgage interest. Under the new system a family would need an outstanding mortgage balance of at least $600K, for their interest payments to exceed the standard deduction.  

Adding additional deductions could push a family over the threshold, but most deductions have been slated for removal. Only the charitable deduction is scheduled to remain. In particular, the state-and-local-tax deduction has been cut.

As Niskanen Senior Fellow Ed Dolan points out, the state-and-local-tax deduction is particularly important for high- income earners in high-tax urban areas. These are precisely the areas that have the highest housing costs and consequently the families with the largest mortgage balances. This creates an interaction effect. Cutting out the state-and-local-tax deduction makes itemizing less attractive to high-income urban families, the types of people who were most likely to use the home mortgage interest deduction. The option to itemize still exists but its constituency has been cut down to the highest-income folks with the most expensive houses.

There is an element of genius to this setup that is worth noting. High-income urban voters are probably the least sympathetic group to the core Republican constituency. Even though some of these people are, of course, Republicans, the GOP does not see itself as the party of the urban elite. This makes targeting the deductions politically palpable. It also leaves an escape hatch for Realtors, one of the most powerful lobbying groups.

While even more taxpayers will be induced to take the standard deduction, the ones with the most expensive houses—that is, the houses  earning the highest commissions—will still itemize.

Political maneuvering is not the most attractive feature in a tax-reform proposal, but the reason it’s worth mentioning is that cutting deductions has traditionally proven intensely difficult. Interest groups are keenly aware of the deductions that apply to them or their customers, and fight to maintain them. Finding a way to cut through that thicket of opposition is an achievement unto itself.

Business Tax Reform

On the business tax code, moving to a territorial corporate system is the most meaningful reform. Right now, U.S. multinationals use a variety of subsidiaries and legal setups to avoid being taxed as U.S. corporations. This is because U.S. corporations owe taxes on all the profits they earn regardless of where those profits were made.

The motivation behind taxing profits where they are earned is understandable. We wouldn’t want U.S. companies to move production overseas just so they could enjoy a lower tax rate. The results, however, are perverse. Instead of moving more production overseas, U.S. companies have created overseas headquarters or subsidiaries, often-times just on paper, and then attributed all of those profits to the headquarters.

U.S. states have faced this type of problem for decades. In one of the most infamous and perhaps humorous cases, Toys “R” Us, created a subsidiary known as Geoffrey Inc. Geoffrey is the name of the giraffe in the Toys “R” Us logo. Geoffrey Inc. owned the rights to use the giraffe’s likeness and it charged a hefty fee. Since all Toys “R” Us stores use the logo, all had to pay huge licensing fees and consequently many ran in the red. As such, they owed little corporate tax. Geoffrey’s, however, made money hand over fist, but because it operated out of Delaware, where intangible assets are exempt from the corporate tax, Geoffrey likewise owed no corporate tax. States moved to undercut these types of machinations, but businesses would adapt and create new schemes. The result was a continual erosion of the corporate tax base.

These same forces are now playing out at the international level. The solution is to abandon the attempt to tax profits wherever they occur and instead focus on taxing economic activity that occurs in the U.S. This does create a form of tax competition. Companies would be incentivized to move out of the U.S. if our corporate taxes were too high. However,  and I know this is a long sell, this isn’t as bad as it might seem.

In the most dystopian scenarios tax competition will lead to a race to the bottom, in which countries wind up driving their tax rates to zero or even below zero to chase corporate jobs. In that world, workers would end up not only shouldering the burden of all taxes but also of subsidies doled out to their employers.

This scenario is unlikely to come to pass. Tax competition is not the only dimension across which countries compete for employers. A skilled workforce, the rule-of-law, infrastructure, proximity to markets, and social and cultural amenities all figure into the calculus. To the extent that these factors increase corporate profitability, corporations will be willing to pay tax to have access to them.

Moreover, to the extent that cutting the corporate tax undermines a nation’s ability to pay for these things, corporate tax cuts will not be job promoting. The reality of tax competition sharpens the trade-off between the cost of taxation and the services those taxes provide, but it does not change the fundamental relationship.

A Tax Cut for the Rich

At the end of the day, isn’t this just about cutting taxes on the rich? Vox co-founder  Matt Yglesias wrote:

Republicans want to pass a large tax cut for high-income households. We know that because the House GOP’s tax reform blueprint features large tax cuts for high-income households, all the various iterations of Donald Trump’s campaign tax plans featured large tax cuts for high-income households, and all throughout Barack Obama’s first term, Republicans fought relentlessly to prevent the expiration of George W. Bush’s temporary tax cuts for high-income households.

There is no doubt in my mind that passing a large tax cut for America’s wealthiest households is a key motivator for some folks within the Republican caucus. The Big Six hope to pass their tax reform through the Republican caucus and so they leave ample room for that to happen. Nonetheless, tax cuts for the rich are clearly not the only motivator here. There is no reason to engage in politically costly reform when all you want to do is get the tax rate down.

Notably the framework left open the door for an unspecified fourth tax rate and included the provision that the new framework be at least as progressive as current law. Now you might think this is just a talking point, but I doubt it. First of all, it’s not very strong. It’s wonkish and vague. If anything it simply sets you up for a bruising critique if you fail to hit the market.

For another thing,  if the epic and humiliating failure of Obamacare repeal has revealed anything it is that legislatures are neither the mindless automatons of some shadowy cabal nor dyed-in-the-wool ideologues who will do what it takes to achieve their parties’ goals.

Not only do the parties have differing interests and allegiances, but they are not even fully aware of what one another’s interests and allegiances are. That’s why they can go up to the wire in both the House and the Senate believing that they have support for a bill only to find at the last minute that they do not.

In short, they face serious communication and coordination failures within their own caucus. The most important function of a document like the framework is not to ever-so-slightly nudge the needle on public opinion, but to herd their own members in line. Without that, they have absolutely no chance of success. To wit, I am guessing that the reason the line about progressivity is in the framework and the door on a fourth tax rate is left open is because the negotiators mean it.

Even more importantly, no matter what the personal motivation of either the Big Six or the Republican caucus as a whole, the simple fact is that this framework does lay out significant reforms. The framework may not hold, and the reforms may be ditched, but that would be bad precisely because some of the ideas within it are good.