Trump tax proposal still doesn’t add up
With improved economy, it makes no sense to boost job growth, writes Joe Chidley.
Let’s be clear: the new Trump tax “plan” is not a plan at all. At best, the sketch outlined by the White House on Wednesday is an opening gambit in a protracted round of horse-trading that might see some degree of tax reform passed, sometime. At worst, it’s a set of ambitions, a wish, a prayer, a hefty spritz of political pixie dust.
Given its advance billing as the most significant tax cut ever, you might have expected Donald Trump himself to validate its historic proportions by actually showing up to announce it. He didn’t, instead trundling out Treasury Secretary Steven Mnuchin and economic adviser Garry Cohn to outline a “broad brush view” on tax reform, as Cohn put it.
Granted, that view pretty much follows the commitments Trump made on the campaign trail, which were also, notably, ultrathin on detail. The main stated goals are to stimulate the economy — Trump has promised three or four per cent GDP growth — and create jobs. To get there, the plan, such as it is, offers a familiar, if dramatic, prescription. It includes cuts to personal taxes, with a reduction of the top tax rate from 39.5 per cent to 35 per cent, and cuts to the capital gains tax (for the wealthy, at least); a dramatic reduction in the corporate tax rate from 35 per cent to 15 per cent, which would be available to so-called pass-through businesses (momand-pop convenience stores and family-owned real estate empires alike); a one-time tax on repatriation of foreign income earned by U.S. businesses; and simplification of the tax code, eliminating most deductions and reducing the number of income brackets to three from seven.
Now, some of these ideas (notably tax code simplification and a shift to a territorial-based corporate tax system) make a lot of sense.
But to put it mildly, success is not assured. The plan excludes any mention of a border tax — good news for Canada, perhaps, but not likely to find favour among some Republicans. Democrats, meanwhile, have already condemned proposed tax breaks for the wealthy, and the White House will need at least some Democratic support unless it can demonstrate the cuts will be revenue neutral beyond the next decade. In that case, a “temporary,” deficit-fuelling tax cut could get passed by a simple majority in the Republicancontrolled Senate. But even that won’t be easy, since in its major aspects the new plan is the same as the one Trump talked up on the campaign trail, which could cost more than US$20 trillion over the next two decades.
On that issue — how much the tax cuts would cost, or how they would be paid for, if at all — there was no detail in Wednesday’s announcement. Perhaps, when the numbers do come through, we can expect some form of the “tax cuts will pay for themselves” argument: boosting GDP will expand the tax base. But history doesn’t offer much evidence for that formula being much more than magical thinking.
Supply-siders often point to the Reagan presidency and its tax reductions as proof that they work to stimulate an economy. But that’s not at all clear from the data. It’s true that GDP grew substantially after Ronald Reagan’s tax reforms came into full effect in 1983: from January of that year to December 1988, the U.S. economy grew at a compound annual rate of 7.6 per cent. But two other important things also occurred during the Reagan years, which show both the similarities and the differences with Trump-world.
First, a similarity: Reagan increased government spending even as he cut taxes, and the federal debt ballooned by 13.7 per cent a year from 1983 to 1988. Like Reagan, Trump also has big spending plans, on everything from infrastructure (a trillion dollars, maybe) to the military and a border wall with Mexico. If he can’t get that money from tax revenue — under this plan, he won’t — or from spending cuts — which he hasn’t detailed either — then he’ll borrow it. That will impact national saving, which will hinder growth, not foster it.
Second, the White House wasn’t alone in trying to stimulate the economy during the Reagan administration. In response to the 1981-83 recession, the U.S. Federal Reserve was busy lowering rates. In June 1981, when the recession began, the effective federal funds rate was a whopping 19 per cent; by March 1988, it had fallen to 6.6 per cent. If the Federal Reserve today were to do that under Trump (assuming he serves two terms), rates would be sitting at -11.75 per cent by 2024.
That highlights the core problem with the Trump tax “plan”: its justification. This isn’t the Reagan era, or even the early Obama era. The U.S. is at or near full employment — so why try to stimulate job growth? There hasn’t been a recession in nearly a decade, and the economy has been growing steadily, if not fast. So why try to stimulate it, especially after a decade of easy monetary policy, which is historically a bigger influence than tax policy on economic growth, struggled to push it to two-per-cent growth? The Fed is in a tightening cycle, which will only put a cap on the White House’s growth and jobs promises.
In short, Trump’s tax plan doesn’t add up. Then again, it’s not a plan at all, is it?