The Republican party is about to give a lot of tax relief to the wrong people.
Since President Trump assumed office, tax reform has been a high priority for both the his adminsitration and the Republican majority in Congress. Earlier this week Trump released the bones of his tax proposal, one which slashes corporate and upper-end tax rates while reforming (and slightly raising) taxes for lower-end payers.
There are two major takeaways to this.
It cuts taxes on the wrong people
"Throughout this framework we see giving with one hand and taking away with the other," said Howard Gleckman, a senior fellow at the Tax Policy Center. "But the basic story here is that middle income people will see very little difference in their tax bills. It's going to make very little difference whether this becomes law or not. The very highest income people will do very, very well and are in line for huge tax cuts."
Republicans have long held that tax cuts create consumer activity that spurs the broader economy. On this basis the administration not only predicts that its plan will pay for itself, but that it will actually double current economic growth. It's safe to say that this will not happen.
Despite announcements to the contrary, the plan (published by the House Ways and Means committee and developed by the White House and Congressional leadership) spends most of its money on high earners. It cuts the top tax rate by 4.6%, eliminates the estate tax, eliminates the alternative minimum tax and lowers the rate for pass-through entities, all of which accrue primarily to the benefit of households earning more than $1 million per year. It does double the standard deduction, but while eliminating personal exemptions and commonly used deductions such as for state taxes.
The result is a plan whose benefits accrue almost exclusively upward.
Estimates vary, but most analyses of this plan find that millionaire households could gain as much as $175,000 up to $250,000 per year. One review by the Center for Budget and Policy Priorities found that these tax cuts will deliver more than $3 trillion to top five percent households over the next three years.
For the other 95% of Americans, the plan will effectively raise taxes by a net $34 billion over that same time period.
"Roughly half the plan's benefits would flow to the top 1 percent of households, who would receive an average annual tax cut of roughly $150,000" said Brenden Duke, a tax policy analyst with the Center on Budget and Policy Priorities. "In contrast, the plan is far more vague about changes that affect working and middle-income people, but likely gives them little if any benefit."
To the limited extent that tax cuts can fuel economic growth, this tends to require low-end tax cuts. The less money someone earns the more likely they are to go out and spend that new money. In particular, bottom-quintile earners are far more likely to take newfound cash and spend it locally, helping the regional businesses and retail sectors that are struggling the most right now.
While money spent on middle- and lower-end tax cuts have some relationship with economic growth, there is absolutely no evidence linking high-end tax cuts with growth. In fact, there is substantial evidence that giving money back to the wealthy does nothing to incentivize either spending or investment. The only macroeconomic impact of this plan will likely be its explosive effect on the deficit.
Corporate tax reform might do some good.
Another major piece of this tax proposal is the corporate tax cut, reducing rates to an anticipated 20% from its current 35%. While it's important to note that many (if not most) corporations actually pay far less than the on-paper rate, according to some analysts this may help spur business development.
"Large U.S. corporations have access to more capital than they want to deploy," said Erik Gordon, with the University of Michigan's Ross School of Business. "And one reason for that is that the high corporate tax rate often makes it less profitable to invest the capital than to use it to buy back shares."
"If you invest capital in depreciable items that produce new income, you get a tax deduction for investment over 10 or 20 years, while the new income is taxed at the prevailing corporate tax rate. If that tax rate is high, the net effect on earnings per share could be less favorable than simply reducing the number of shares via buybacks."
There is room for corporate tax reform to help encourage business development and make the U.S. more globally competitive, but much of the value will depend on the details. According to the U.S. Treasury, between 2007 and 2011 companies worth over $10 million paid an actual tax rate of about 22%. That dropped down to an effective rate of 10% for utilities industries and 19 percent for banks and finance.
The question, then, will be how Republicans structure preferences and loopholes. A plan which cuts the top tax rate by nearly half, while leaving the rest of the system intact, could lead to a nearly tax-free business environment. That might help spur some growth, but the impact of further capitalization through tax cuts would be questionable in an environment where many major businesses already have trillions of dollars in unspent cash.
At the same time, a tax cut without reform would be immensely expensive. While there's no evidence that the deficit has yet slowed down U.S. growth, many economists have expressed concerns about adding trillions of dollars of debt at a stroke.
If properly planned, corporate tax reform could help incentivize companies to start and conduct more business in the United States. They key will be paying for it in an environment where corporate tax receipts already come in far below the legislated rate.
And as far as Republicans' proposed individual tax cuts go, those will do nothing but spend approximately $5.8 trillion making the rich richer.
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