A tax cut sounds appealing, but could we afford it?
Reader feedback at end.
The president has promised to revitalize the US economy, thereby fostering faster growth and the creation of good paying jobs. To this end, it is proposed to (1) roll back burdensome regulations, (2) implement tougher international trade policies, and (3) reduce the burdens of the tax system. How goes the battle?
#Some successes have been achieved in easing regulatory burdens, particularly in cases where this could be accomplished by executive action. There will be lots of political pushback against significant policy changes, however, and seemingly endless legal challenges. As an example of how gritty supporters of the regulatory state can be, consider the March for Science on April 22 (previewed in our 4/17/17 blog entry) and the Climate March on April 29.
#There has been a flurry of executive actions re international trade including withdrawal from the Trans-Pacific Partnership and initial moves to renegotiate the North American Trade Agreement. For reasons discussed last week, however, big benefits for the US economy seem unlikely. Think twice about “America first” trade policies, 5/1/17.
#Some see tax reform as the best hope for quick economic gains. If taxes on business and individual income are cut, they reason, this will encourage Americans to invest more and work harder. And the longer that action is deferred, the longer Obama era tax hikes will dampen economic growth. A subpar economy looms, Donald Lambro, Washington Times, 5/4/17.
The Republican leadership in Congress needs to get its priorities straight and get with the program to breathe new life into our moribund economy. Tax reform is needed now.
House Republicans published a tax reform blueprint last summer. Campaign issues: “A better way,” section 6, 7/25/16. But all they envision accomplishing this year is a corporate tax overhaul, with individual tax changes to be taken up later (given how things work in DC, that might mean never).
Key corporate tax changes would include reducing the top rate to 20%, current expensing of capital investment, eliminating deductions for interest expense, and a border adjustment feature (exempt exports, tax imports) that would bring in an estimated $1 trillion in net additional tax revenue over the next decade. Proposed replacement for the corporate income tax, 2/13/17.
The administration is working on its own tax plan, which would promise substantial tax cuts without attempting to “pay for” them. Trump: “Most extensive tax reduction in history,” bigger than Reagan’s, Paul Bedard, Washington Examiner, 4/24/17.
•The corporate tax rate will "be very low [15%]. It will put us among the lower countries."
•"Individually people will be extremely happy and they're going [to] get a big tax cut. The middle class of our country have been absolutely mistreated miserably."
On April 26, the president’s top tax advisers previewed his tax plan at a White House press briefing. A one-page, bullet point handout was provided, and when reporters pressed for more details the presenters nimbly ducked (see examples below). Briefing by Treasury Secretary Steven Mnuchin and National Economic Council Director Gary Cohn, whitehouse.gov, 4/26/17.
Director Cohn described the personal tax changes that are envisioned: Reduce the current 7 tax brackets to 3 brackets of 10%, 25% and 35% (current top rate is 39.6%). Double the standard deduction (to $12K, or $24K for a couple filing a joint return), which would eliminate the use of itemized deductions for most taxpayers. Provide tax relief for families with child and dependent care expenses. Eliminate personal tax deductions except for mortgage interest and charitable contributions. Repeal the Alternative Minimum Tax and the estate [aka death] tax. The 3.8% GovCare tax on small businesses and investment income would also go, thereby reducing the top tax rate on capital gains and dividends to the previous level of 20%.
Q On the 10, 25, and 35 percent rates, do you have income brackets established that you're going to propose?
DIRECTOR COHN: Again, we are in constant dialogue with the House and the Senate. As the Secretary said, we're holding a bunch of listening groups right now. We have outlines; we have a broad-brush view of where they’re going to be. We're running an enormous amount of data on the proposals right now. We will be back to you with very firm details. We're very confident to where they’re going to be, we just wanted to get out and give you a broad-brush overview [of] where we are.
Secretary Mnuchin covered business tax changes: 15% rate (which would apply for standard corporations, and also for pass-through entitles such as partnerships and Subchapter S corporations), switch to a territorial tax system in line with most other countries versus the current US approach of taxing worldwide income on a remittance basis (tax on undistributed earnings of foreign subsidiaries is deferred), impose a one-time tax on undistributed foreign profits (estimated to total some $2.5trillion), and “eliminate tax breaks for special interests.”
Q If you don't replace some of the revenue with the border adjustment tax, how will you make up for the deficit caused by the reduction in the corporate tax rate?
SECRETARY MNUCHIN: Well, again, today we're putting out the core principles, which include rates because we think that's a very important part of the plan. We will be working very closely, as I said, with the House and the Senate to turn this into a bill that can be passed and the President can sign. And there’s lots and lots of details that we're going into how that will pay for itself.
Initial reaction to the president’s tax plan was generally positive, e.g., a poll indicated that 48% of Americans were in favor while only 31% of Americans said Congress should disregard it. This is a better rating than the House Republican tax plan has reportedly received. Nearly half of voters like Trump’s tax outline, Joseph Lawler, Washington Examiner, 5/3/17.
It would be pleasant to agree with the majority, but before doing so let’s consider three questions about the president’s tax plan.
A. Is the plan saleable? – Until dollar parameters for the new personal tax brackets are set, there will be no way of determining how individual tax payments would be affected. One would gather, however, that most Americans who currently pay income taxes would wind up with a lower bill and nonpayers would be no worse off.
As for a cut in corporate income taxes, what’s not to like about that? The burden of corporate taxes is passed on to consumers, according to most economists, so everyone should benefit.
Tax compliance (and enforcement) would be simplified, e.g., by doubling the standard deduction to reduce the utilization of itemized deductions and abolishing the Alternative Minimum Tax.
In sum, the president’s plan seems to offer a lot of benefits without any obvious drawbacks. And it was politically astute to combine business and individual tax reforms in a single package rather than trying to pass them sequentially. Trump’s finest moment (so far), Kimberly Strassel, Wall Street Journal, 4/27/17.
The Trump proposal has galvanized all those groups that wield influence with Republicans. “Trump Plan Will Turbocharge the Economy,” crowed Americans for Tax Reform. “This is What Pro-Growth Tax Reform Looks Like,” declared the Club for Growth. It’s also a proposal to inspire voters, since it offers relief to nearly every category of taxpayer. Congressional Republicans can move ahead knowing they have support, even as they feel pressure to get the job done.
B. Is the plan equitable? – Critics of the president’s tax plan claim that it would primarily benefit the affluent, and there can be no doubt that Americans in this category would benefit – even after factoring in elimination of many currently available tax benefits, e.g., deduction of state and local income taxes. Trump’s tax plan seen as boon for rich, unclear for middle class, Sahil Kapur, yahoo.com, 5/1/17.
Cut top tax rate by nearly 5 percentage points – eliminate Alternative Minimum Tax that mostly applies to “certain taxpayers in the higher end of the income scale” – eliminate 3.8% investment income surcharge under the Affordable Care Act for high income (over $200K per year) taxpayers – repeal the estate tax, saving an estimated $200B over the next decade ($20B per year) for decedents with $5.45M+ estates – reduce tax on “pass through” businesses such as law firms and business empires (e.g., Trump’s) to 15%, which one observer called “a great, juicy benefit for higher income people” – and keep "the popular (and costly) tax deductions for mortgage interest and charitable contributions.”
Middle class taxpayers should come out ahead due to doubling of the standard tax deduction, but their aggregate benefits can’t be even roughly estimated until dollar levels are established for the three tax rate brackets. And Americans who aren’t currently paying income tax wouldn’t get any benefit at all. So how fair is the president’s tax plan? Not very, suggests economist Alan Blinder, calling it “remarkably regressive.” The White House rejects tax reform for the old tax cut formula, Alan Blinder, Wall Street Journal, 4/30/17.
You may recall that Treasury Secretary Steven Mnuchin once assured the public that “there will be no absolute tax cut for the upper class.” That would have been a departure from the Republican Tax Cut Formula. But we now see it isn’t true. If the plan ever gets fleshed out and priced, we may learn that, in dollar terms, it gives more new loopholes to the rich than it takes away.
However, this line of attack rests on an unstated premise - the affluent aren’t paying their fair share of the overall tax burden under current law, so any tax cuts for them would be a giveaway – which is arguably untrue.
It’s well known that affluent Americans pay tax at higher rates than the economic hoi polloi, as shown by this recap for 2014 (the most recent year for which IRS collection data are available). Taxpayers in the top 1% of Adjusted Gross Income group (AGI of $466K or more) paid 39.5% of the tax on 20.6% of the income. Taxpayers in the top 5% (AGI of $189K or more) paid 60.0% of the tax on 36.0% of the income. And so on down to the bottom 50% (AGI of $38K or less), which paid 2.8% of the tax on 11.3% of the income. National Taxpayer's Union, accessed 5/5/17.
Accepting that ability to pay should be considered in designing a rational tax system, it’s difficult to conclude from these data that affluent taxpayers are not currently paying their “fair share.” If a valid claim of inequity is suggested, it would seem to lie in the distribution of pretax income rather than the tax that is paid thereon.
Asking who stands to benefit from the president’s tax plan is certainly in order, although reliable answers will be dependent on further details, but the plan shouldn’t be rejected simply because taxes would be cut for the affluent (who currently pay a disproportionate share of total taxes) as well as for lower income taxpayers.
Here’s another perspective. To the extent that proposed tax cuts would boost overall economic output, it might be shortsighted to reject them due to disagreement about who should get the biggest cuts. Why not focus on how to grow the economic pie, in other words, instead of how the pie should be divided? Trump vs. Schumer on taxes, Star Parker, townhall.com, 5/3/17.
Liberals think that you help Peter by taking from Paul. I think you help both Peter and Paul by creating the best possible conditions for opportunity for both of them. *** Tons of data and studies show that countries that have the most economic freedom -- good laws that protects life and property, low taxes, nonintrusive regulation, limited government -- are the most prosperous. And even the poorest in these countries are far better off than the poorest in countries without economic freedom.
All things considered, the argument that the president’s tax plan would be inherently inequitable does not seem persuasive. So let’s move on to the third and final question.
C. Is the plan fiscally responsible? - Balancing the budget is the centerpiece of SAFE’s policy agenda, and there are just so many ways to go about it. Cut spending (unpopular) – raise taxes (also unpopular) – grow the economy faster (boosting government revenues without tax increases) – default on the debt so as to reduce interest expense (very messy).
Cutting taxes (popular) may accelerate economic growth, but is almost sure to reduce government revenues in the short term unless tax rates have been set way too high. The possibility that tax cuts would generate higher rather than lower revenues was suggested by the famous Laffer Curve (a graph showing tax revenues growing as rates are raised until an inflection point is reached, after which tax revenues decline to the vanishing point), and arguably borne out by robust economic growth after the Kennedy tax cuts in the 1960s and the Reagan Tax cuts in the 1980s. They were talking about the Laffer Curve in 1963, Brian Domitrovic, forbes.com, 10/21/14.
Tax rates are currently lower now than they were in 1981, let alone 1963, and few economists would predict revenue gains from the president’s tax plan in the short term. But it has been argued that fiscal conservatives should support tax cuts anyway, as the real problem is government spending rather than deficits per se. Republicans must stop talking about revenues and “budget deficits,” John Tamny, affluentinvestor.com, 5/3/17.
The main thing is that taxes are way too high. They should be much lower, ideally so low that federal revenues plummet. Just once it would be nice if Republicans would promote tax relief that penalizes American workers less all the while reining in politicians a great deal more. One can fantasize, but if history’s any kind of indicator, Republicans are set to resume yet another debate about growth and revenues that will hand the terms of the debate over to the left. With politicians, and this includes Republican politicians, freedom is always an afterthought.
Although philosophically appealing, this line of reasoning is overstated. Chronic deficits and soaring debt do matter, and disastrous consequences should be expected if the government fails to get its financial affairs in order. Excessive spending may be the root cause of the fiscal problem, but our political leaders haven’t demonstrated much interest in cutting spending either. David Stockman [the first budget director in the Reagan administration]: Trump’s tax plan is “dead on arrival” and Wall St. is “delusional” for believing it, Amanda Diaz, cnbc.com, 4/30/17.
The president is "essentially a 70-year old kid in a candy store who wants one of everything: More for defense, veterans, border walls, law enforcement, infrastructure and 'phenomenal' tax cuts, too—without the inconvenience of paying for any of it."
As the president’s tax plan is fleshed out, we hope that the net reduction in tax revenue (on a dynamic scoring basis) will be held within reasonable limits. Discussion follows of various options for doing this, including several that seem like nonstarters and others that we would be inclined to favor.
# Impose a new tax that would arguably serve some worthwhile policy objective. Several candidates have been suggested, none of which strike us as appealing.
•The “border adjustment” feature of the House Republican’s proposed replacement for the corporate income tax is politically problematic as it would split the otherwise supportive business community into two opposing camps. And such adjustment is not needed from an economic standpoint – as some proponents have claimed – to level the playing field for US vs. foreign firms. The border-adjustment sleight of hand, Veronique de Rugy & Daniel Mitchell, Wall Street Journal, 4/16/17.
•Instituting a value-added tax to supplement the income tax has been talked about, and many countries have both such taxes. However, the administration has denied that a VAT (which would greatly increase the tax burden on the US economy, and most likely fuel a disastrous spending binge as well) is being considered. White House disavows two controversial tax ideas [the other being a carbon tax] hours after officials say they’re under consideration, Damian Palletta & Max Ehrenfreund, Washington Post, 4/4/17.
•Here is perhaps the worst tax proposal we’ve seen; it would combine three bad ideas in a single “border adjusted, carbon tax swap” package. A tax plan to stop climate change, theenergycollective.com, 5/1/17.
#Set the income tax rate brackets so tax cuts for the middle class and affluent taxpayers won’t be excessively generous. From comments at the White House briefing on the president’s tax plan, this is what the president’s advisers intend to do.
#Consider eliminating two features of the president’s tax plan that would primarily benefit affluent taxpayers, thereby not only reducing revenue loss but also helping to allay concerns about the plan being regressive (see discussion of question 2, infra).
•Forget about eliminating the estate tax, which would only benefit the truly wealthy (including the president and his family) and isn’t related to an overhaul of the income tax system anyway.
•Deductibility of mortgage interest tips the scales in favor of owning versus renting homes. The real estate industry is already up in arms about the proposed doubling of the standard deduction (which would greatly reduce the number of taxpayers deducting mortgage interest), so the political cost of eliminating this deduction entirely would be modest. Houses of lobbyists, Wall Street Journal, 5/5/17.
The shame is that neither Mr. Trump nor House Republicans are proposing to eliminate the deduction for mortgage interest. They know it would be good tax policy but they figure it’s too politically difficult. Yet the housing lobby gives them no credit and still yelps about the standard deduction.
#Avoid taking on new fiscal commitments, which would effectively add to the cost of the tax package.
•Drop the contemplated “relief for families with child and dependent care expenses” (reportedly suggested by Ivanka Trump); the last thing American taxpayers need is another entitlement program!
•Put proposed infrastructure improvements on a businesslike basis, e.g., make users (versus the general public) bear the costs. In the case of roads and bridges, for example, this might suggest an increase in motor fuel taxes. Fixing the highway trust fund, 8/3/15. There have been indications that the administration might be willing to consider such an increase. Spicer: Trump listened to gas tax hike proposal, but hasn’t endorsed, Kyle Feldscher, Washington Examiner, 5/1/17.
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Summing up, the House Republican tax plan will be subsumed by the president’s tax plan, which is simple, comprehensive, and more politically astute. Claims that the president’s plan would represent a giveaway to the wealthy are overstated, but concerns about its impact on the government’s fiscal position are valid. Our suggestions on how to limit the revenue loss from tax cuts have a common theme: don’t overdo it.
#Thanks for the thorough review of Trump’s tax reduction plans. Personally, I hate to lose local tax deductions and medical/health deductions; doubling of the standard deduction won’t fully offset my loss. And Trump made a big point of reducing tax brackets from 5 to 3, but aside from reducing the top tax bracket it’s unclear how this will help us. (Effect of cuts for middle class taxpayers can’t be evaluated until the dollar breakpoints are announced.) Agreeing to continuation of the “death tax” would not be such a big deal. Folks in that lofty category can avert forced liquidations of family businesses, etc. by taking out insurance coverage. – SAFE director
#If tax cuts diminish the size of the Fed. gov't, that’s great. If all they do is add to the debt, that’s bad policy! – SAFE member (DE)
# You suggest “overly generous tax cuts could exacerbate the fiscal problem.” Is a 15% corporate tax rate “overly generous?” The rate in Ireland is 12.5%. – SAFE director
In principle, a 15% corporate rate seems quite defensible. However, a 20% rate was used in the House Republican plan, and there’s been speculation that the president chose the 15% rate to leave room for compromise in the tax bill negotiations.