The Republican tax rewrite that has now passed both House and Senate represents a legislative triumph for one core idea: that lighter tax burdens mean more economic growth.
Right now, it’s not just the sales pitch behind the tax plans, it’s arguably the idea that most unites a Republican Party challenged by internal divisions and electoral uncertainty.
“If we can’t do better than 1.9 percent [growth], we’ve got real problems in this country,” Sen. Rob Portman (R) of Ohio said last week, citing the current growth rate projected for the next decade by the nonpartisan Congressional Budget Office.
But now comes the test: Will the theory turn into economic reality? Will the virtue of tax cuts ring true for the voters who will decide coming elections?
Many economists say the House and Senate plans – which now must be reconciled into a final bill – may serve more as a giveaway to the rich than an enhancer of growth.
At the same time, wage growth and gross domestic product have disappointed in recent years. During seven years of recovery since the Great Recession, not once has GDP notched a calendar-year gain of 3 percent or higher. It’s not just economists on the political right who see a connection between growth and the health of America's social fabric. Many finance experts say lower corporate tax rates could boost long-term growth, at least modestly.
“The corporate rate cut by itself certainly should be a pro-growth provision,” says Alan Viard, a resident scholar at the conservative-leaning American Enterprise Institute (AEI) and former senior economist at the Federal Reserve Bank of Dallas. “Telling companies both American and foreign-chartered that they can keep 80 percent of their profits operating in the US instead of 65 percent should make the United States a more attractive investment location. So you should see capital flow to the United States, which would make American workers more productive and would drive up their wages.”
The GOP bills would cut the top tax rate on corporations from 35 percent of income to 20 percent, while also reshaping the individual side of the tax code.
The idea of reducing nominal tax rates on corporations has had fans on the left, such as former-President Barack Obama, as well as on the right. The centrist Information Technology and Innovation Foundation is among those seeing a potentially sizable long-term boost in GDP from such reform.
The US stock market has rallied as prospects for passage of the tax legislation have improved.
But if many economists embrace the idea of making US corporate tax rates more competitive with those in other advanced nations, that doesn’t mean they necessarily like the GOP bills. Some see the tax plans adding a bit to long-term growth, but other prominent forecasters including Goldman Sachs and the Tax Policy Center forecast almost no GDP boost from the plan after 10 years.
And Republicans in Congress have pledged not just growth, but that Americans at all income levels will participate. Polls show voters are skeptical, and nonpartisan analysis by the staff of Congress’s Joint Committee on Taxation shows big benefits flowing to the rich under both the House and Senate plans, while the Senate version causes tax cuts for individual taxpayers to expire after 2025.
“It’s more of a sugar high” than a recipe for long-term growth, says Kimberly Clausing, an economist at Reed College in Portland, Ore. “And it’s a sugar high for those at the top of the [income] distribution.”
The Republican tax packages do contain some progressive components, such as limiting mortgage-interest deductions that help higher-income families the most, Ms. Clausing says.
A larger standard deduction, present in both plans, would give a tax break to many moderate-income households. So would an enlarged child tax credit.
But the bills also contain controversial elements. Eliminating the deduction for state income taxes hurts many taxpayers from high-tax states. Removal of Obamacare’s mandate to have health insurance, or pay a tax penalty, is projected to result in both fewer Americans with insurance and higher premiums.
Tax-rate cuts for individuals expire in the Senate bill, while both bills contain big tax breaks for the rich – from curbing the estate tax to reducing taxes on “pass-through” business income. And to the degree that tax cuts add to deficits, it may result in cuts to programs including Medicare unless Congress passes new budget plans.
Even conservatives are worried.
“The GOP had better hope and pray [President Trump’s] program instigates more widely distributed opportunities,” writes University of Maryland economist Peter Morici, or faster growth alone “won't save the party from major setbacks in the upcoming midterm and 2020 elections.”
Some studies suggest that previous tax cuts under former-Presidents Ronald Reagan and George W. Bush did help boost growth. In a 2006 study, the US Treasury Department found that tax cuts in 2001 and 2003, along with cuts in interest rates, helped move the economy out of recession and onto higher growth path, perhaps adding up to 3 million extra jobs by the end of 2004.
The idea that tax cuts can entirely pay for themselves through “dynamic effects,” as faster GDP growth expands the income base for taxes, is being pushed mightily by some Republicans in Congress. Few economists embrace that idea.
How to pay for cuts
But debate has flared in recent days over whether mainstream forecasts are too pessimistic on how much of the potential revenue loss can be recovered through growth. A Joint Committee on Taxation report Thursday envisioned a possible extra $600 billion in revenue under the Senate tax bill over the next 10 years, compared with a traditional or "static" forecast of the bill's effects. But the report upset Republicans because that still would leave projected deficits $1 trillion higher during that time, as a result of the tax measure.
Even the Bush Treasury report noted that the effects of tax cuts on long-term growth depend on how they’re paid for. If it’s by spending cuts, positive growth effects might remain. But if tax cuts today are financed by tax hikes tomorrow, tax cuts actually mean lower GDP in the long run, the report concluded.
That’s just one of many studies, but it hints at a crucial economic and political challenge facing Republicans as they finalize their plan. The national debt is high, rising, and increasingly driven by entitlement costs that are hard to tame.
Efforts to boost GDP growth can be part of the solution.
“We’ve got to deal with the growth side if we’re going to get the debt and deficit under control,” Senator Portman said last week.
The track record for deficit control is not promising. The debt and deficits have risen under every president since Mr. Reagan, with the partial exception of Bill Clinton, who saw deficits fall under his tenure. Reagan accounted for the largest percentage increase in deficits; Mr. Obama for the largest dollar amount.
“It’s a perennial pattern,” says Mr. Viard of AEI about the rising debt. “Eventually, we will have to take action on it, but it will require a bipartisan agreement. Neither party is going to be in a position to make serious progress alone.”