Tax changes hard to interpret

There’s hasn’t been major reform since Reagan signed act in 1981

The dense fog that rolled in off the Pacific as President Ronald Reagan signed the Economic Recovery Tax Act of 1981 is an apt metaphor for the difficulty in glimpsing the consequences of major changes to the U.S. tax code.

With its large cuts in individual rates and revolutionary treatment of business depreciation, the 1981 Reagan tax bill easily qualifies as both major and historically significant. Few economists doubt that the legislation contributed — along with falling interest rates — to the economic boom of the 1980s.

Though the ERTA was advertised as revenue neutral, it turned out to be a budget buster. Thanks to higher defense spending as well, the federal deficit ballooned from an average of 1.8% of gross domestic product in the 1970s to 4% from 1982 through 1989. Over that same period, the federal debt grew from $998 billion to $2.8 trillion.

Relative to GDP, however, the federal debt stood at only about 31% in 1981, down from 46% in 1964. And when the next major piece of tax legislation was enacted in 1986, the debtto-GDP ratio had returned to the level of the mid-1960s.

Recent budget deficits as a share of GDP are not especially large by historical standards, yet their accumulation over the last three-plus decades has pushed the nation’s total indebtedness to almost $20 trillion, or slightly more than 100% of GDP.

It is in that more challenging fiscal context that the Trump administration plans the most ambitious rewrite of the tax code since the Tax Reform Act of 1986, which cut the top corporate rate to what at the time was the lowest in the developed world. The Trump plan also will contain changes to individual rates, but its centerpiece — and area of maximum contention — will be corporate tax reform.

Trickle-down redo

Despite the success of the 1986 bill, there is reason to be skeptical of the 2017 version.

President Donald Trump has framed the yet-to-be specified reforms in populist terms, i.e., that by cutting the top corporate tax rate from 35% to 20% or below, the benefits will trickle down to millions of middle-income employees.

“Lower taxes on American business means higher wages for American workers,” the president said in a recent speech.

But according to Sarah Anderson, director of the Global Economy Project at the Institute for Policy Studies, the record does not support that view.

IPS describes itself as “a progressive think tank dedicated to building a more equitable, ecologically sustainable, and peaceful society.”

Anderson identified 258 publicly held U.S. corporations that were profitable for each of the eight years through 2015 and then looked at employment data of the 92 from that group that had effective federal tax rates below 20%.

Those 92 companies registered median job growth of minus-1% compared with 6% for all private sector firms. The 48 companies that actually cut jobs — 483,000 of them — nonetheless found the financial wherewithal to pay their CEOs an average of $14.9 million in 2016, or 14% more than that for all S&P 500 companies.

“Corporate profits are now at record levels, so companies don’t lack the resources to hire more workers and invest in new technologies that might raise productivity and wages,” Anderson said in a recent phone interview. “But they don’t see those items as priorities, and I doubt that giving them a cut on their tax rate will change that.”

Under current law, companies are granted a virtually unlimited tax deduction for performance-based pay, a loophole that incentivizes CEOs to engage in financial engineering, such as buying back company stock.

“Ordinary taxpayers subsidize excessive executive pay because companies can write off almost all of it,” Anderson said.

Though the top corporate rate is 35%, the effective rate is only 22%. And as a share of GDP and federal revenue, U.S. corporate income taxes have fallen by two-thirds since the 1950s while after-tax corporate profits (relative to GDP) have tripled since the mid-1980s. Meanwhile, U.S. nonfinancial companies are sitting on $1.9 trillion in cash, of which $1.1 trillion is held overseas.

Would workers benefit if those earnings were brought home?

In 2004, U.S. corporations were granted a tax holiday on foreign profits. The top 15 repatriating companies responded by cutting 20,931 jobs.

Nothing says thank you quite like a pink slip.