In laying down a sweeping tax reform Thursday, House Republicans have put all their trust into a central tenet of conservative thought: Tax cuts will spur growth.
By itself, it may not be that controversial an idea. But for the current US economy, it’s also not the obvious need.
In fact, a big challenge for the GOP is to show that its specific mix of tax cuts will provide enough short-term oomph to America’s economic engine now that it will have enough momentum to counter some of the long-term drag from more federal debt.
And that is an iffy proposition, economists say. It depends on two things: the timing of tax cuts and whether they make the economy more competitive.
From a timing perspective, the Republican tax cut looks odd. The economy is growing steadily. Wages are growing, albeit slowly. Unemployment is very low by historical standards.
Do America’s taxpayers really need a stimulus to spend more? Probably not.
“If you have tax cuts [to fight] a recession, that’s one thing,” says Michael Klein, an economist at Tufts University's Fletcher School of Law and Diplomacy in Medford, Mass. But “if we’re already at full employment, it’s not clear how much you can goose the economy beyond that.”
Seeking to bring profits back from overseas
But from a competitiveness standpoint, the need for tax reform is urgent, Republican officials and some economists say.
The United States has the highest corporate tax rate in the developed world. By slashing it, the GOP has a chance to make US businesses more competitive internationally. And through various other reforms, the United States will eliminate loopholes and make it easier for multinationals to invest their foreign profits back into the US.
Even if, by eliminating loopholes, some industries pay more in corporate taxes, reform has the advantage of shifting incentives toward industries that provide the most economic growth, rather than those with the most lobbying power in Washington.
“It is an incredibly historic opportunity that we are embarking on,” says Jonathan Williams, chief economist of the American Legislative Exchange Council, which represents conservative state legislators. “Hopefully, we’ll be able to give the American people a Christmas present.”
But the GOP faces a problem in getting corporate tax cuts through Congress. They’re about as popular as fruitcake. In a CBS poll released Wednesday, only 17 percent of respondents wanted corporate taxes reduced; 56 percent said they should be increased.
Do tax cuts boost growth?
So the Republican leadership is twinning corporate tax reform with tax cuts for individuals, almost across the board, in a package they’re pitching as “pro-family, pro-growth.” Polling suggests the idea of lightening tax burdens on the middle class is a popular idea with the American public.
And economists generally see an opportunity to modestly boost gross domestic product (GDP) through reforms that simplify the tax code in a “revenue-neutral” way. Lower tax rates, with fewer deductions, might create a tax code with stronger incentives to work and invest.
With revenue-losing tax cuts, the view shifts. In the short run at least, a cut in taxes can provide a stimulus by putting more money in people’s pockets. Longer run, the effects aren’t so clear. In a nation with high and fast-rising public debt, and chronic deficits, a risk is that tax cuts financed by borrowing will if anything slow future growth, by worsening the nation’s credit rating and adding to the tax burden of future generations.
By blending reform and tax cuts, the Republican plan would be the most ambitious tax-code overhaul in 31 years, while deepening official deficit projections by $1.5 trillion over the next 10 years.
What’s in the plan?
On Thursday, House Speaker Paul Ryan touted the stimulative impact of putting an estimated $1,200 a year back into the pockets of a typical family of four.
“About half the country today is living paycheck to paycheck,” Mr. Ryan said in introducing the legislation. “If we don’t do this, we will not get the kind of economic potential that we know we can reach.”
For individuals, the plan developed by the House Ways and Means Committee would generally reduce tax rates, shrink the number of tax brackets, and eliminate the estate tax, while retaining some popular deductions (notably for retirement savings, property taxes, and interest on mortgages below $500,000). But state income taxes would no longer be deductible, a highly controversial blow to residents of high-tax states.
A question of timing
Why now? One big reason is political. Republicans have long wanted to try for a tax overhaul, and now control both the White House and Congress. But the math of passing a partisan bill is, well, taxing. Republicans are aiming to pass a parallel bill in the Senate with only a two-seat majority. Sen. Susan Collins (R) of Maine has already said she’s worried about a bill that adds to deficits.
The more substantive rationale is economic. The tax plan comes as annual GDP growth hasn’t clocked in above 3 percent (about its annual longer-run average) since 2005. The aspiration for stronger growth was a central theme of Donald Trump’s winning presidential campaign.
Yet the nonpartisan Congressional Budget Office (CBO) has official forecasts of future growth of 2 percent a year. The reasons reflect the two main drivers of growth – the size of the labor force and its productivity. Better policies including on taxes might incentivize more people to work and more businesses to make productivity-enhancing investments.
It’s not just Republicans who think so.
“I strongly support tax reform in general and especially corporate tax reform on the model of the highly successful bipartisan 1986 tax reform,” Lawrence Summers, Treasury secretary under President Bill Clinton, wrote recently. “[It] achieved very large rate reductions, spurred economic growth and improved the efficiency of the economy.”
And Democrats don’t all dismiss the potential of tax cuts to boost growth. Christina Romer, who served as President Barack Obama’s top economic adviser, co-wrote a paper in 2010 concluding that “tax increases appear to have a very large, sustained, and highly significant negative impact on output, … [and] tax cuts have very large and persistent positive output effects.”
Deficits matter, many say
What economists widely dismiss, though, is any argument that a tax cut will boost growth so much that it “pays for itself.” And many question if deficit-financed tax cuts can boost long-term growth at all.
A recent survey of economists working largely for US businesses may be telling. Some 62 percent said they’d like to see policies to reduce federal deficits, versus 9 percent who want higher deficits, according the the August poll of members of the National Association for Business Economics.
And of course, the tax changes have many moving parts.
Although Americans generally want the rich to pay more in taxes, not less, this plan goes the other way with things like repealing the estate tax. The package also preserves the top tax bracket of 39.6 percent in 2017 income tax. But instead of a 2017 threshold of $470,700 per family, the House plan moves that up to $1 million. So assuming all other things held steady, a family earning $750,000 this year would see a tax rate decrease from 39.6 percent to 35 percent – a possible tax break of about $34,500.
Overall, a Tax Foundation illustration estimates that Americans’ after-tax earnings would rise anywhere from zero to about 2 percent in five sample households earning less than $200,000. Higher-income taxpayers could see even bigger gains, with after-tax earnings up 2.6 to 9 percent for three sample households. [Editor's note: This paragraph has been updated to reflect corrected numbers from the Tax Foundation website.]
But contrast those changes to the near halving of the corporate tax rate from 35 percent to 20 percent. That would be a huge change. And even if many corporations don’t pay that amount, because of a bevy of loopholes, the new rate represents a serious attempt to redress the US international competitiveness versus nations with their own low rates.
But the vetting and debate over the tax plan’s details has only begun.
“Well-designed tax policies have the potential to raise economic growth,” economists William Gale and Andrew Samwick of the Tax Policy Center and Dartmouth College, respectively, wrote in a paper last year. “But there are many stumbling blocks along the way and certainly no guarantee that all tax changes will improve economic performance.”