Trump's Tax Cut Will Be Small Once Congress Is Done With It
President Trump isn’t draining the swamp. He unveiled his long-awaited “tax reform” package last week, and although many crucial details were missing (for example, the income brackets), he was full of accolades. “This is a revolutionary change,” he said.
Well, not yet.
The federal income-tax system — almost everyone seems to agree — is a mess. It features relatively high nominal rates (up to 39.6 percent on individual income and 35 percent on corporate income) whose impact is offset by a baffling array of tax breaks, loopholes, preferences or “tax expenditures,” depending on which buzzword is in fashion.
A truly revolutionary tax overhaul would eliminate most existing tax breaks and use the resulting surge in revenues to lower rates sharply. But Trump may only partially rely on this process. He may also borrow to cut taxes. The crux of the debate is whether the tax cuts will pay for themselves, through higher economic growth, or whether they will simply add to the debt.
Economist Diana Furchtgott-Roth of the Manhattan Institute, a Trump supporter, argues that reducing the top corporate tax rate to 20 percent will cause more internationally based companies to locate in the United States and fewer American firms to flee abroad to lower-taxed countries. Kevin Hassett, head of Trump’s Council of Economic Advisers, makes a similar point: “Particularly [for corporations], there is a deep literature that has found that capital investment is highly responsive to changes in tax policy.”
Reduce tax burdens, and companies will respond. Economic growth will increase; the tax cut will pay for itself.
Wishful thinking, say many economists. Deficits will grow, neutralizing some or all of the gain from lower tax rates. The logic is simple: Larger federal deficits will drive up interest rates, crowding out private-business investment.
Just how much more debt the Trump plan might involve is unknown, because so many details (including the distribution of the tax cuts across income class) remain undecided. But an estimate by the nonpartisan Committee for a Responsible Federal Budget puts the figure at $2.2 trillion over a decade. That’s on top of projected added debt of about $10 trillion in the same 10 years from present policies.
This returns us to “the swamp,” Trump’s colorful metaphor for all the Washington lobbying for federal money, tax breaks and favorable regulation. He suggests that the process is corrupt, and often it is. But mainly it is democracy in action: groups arguing that they deserve special help. Regardless of whether it’s corrupt or not, Trump has inveighed against the swamp more than he has actually tried to drain it.
To do that, he’d have to challenge many more tax breaks. There is no shortage of targets. The 2018 federal budget lists 167 tax breaks; the costliest 15 alone lose roughly $1 trillion in tax revenue a year. Public benefits are often dubious. Consider two big tax breaks: the mortgage interest deduction for homeowners and the tax-free treatment of employer-paid health insurance. Arguably, both have had ill effects: The mortgage deduction has caused Americans to overinvest in housing, and the insurance break feeds medical inflation.
Still, it’s hard to oppose tax breaks that have such large constituencies. Similarly, tax breaks allow politicians of both parties to announce their support for various economic and ideological causes. Thus, we have tax breaks for college costs, wind and solar power, and corporate research and development. Also, some tax breaks surely do good. Would people save as much for retirement without tax-favored 401(k) and IRA accounts?
As a nation, we’d probably be better off with a simpler income-tax system with much lower rates and a much broader base. People and companies would decide what to do with their money rather than have government push and pull them through various legal bribes, rewards and punishments. That would relieve pressure on government to do more and more — often raising unrealistic expectations.
In Trump’s vocabulary, the swamp would begin to contract. There might be fewer tax lawyers, lobbyists, accountants, economists and publicists. This would be good but is also unlikely.
The political logic preventing such a system is daunting. No recent president, with the exception of Ronald Reagan, has tried. Indeed, Reagan’s experience is instructive. With bipartisan support, he succeeded in reducing rates and broadening the tax base in the Tax Reform Act of 1986. But President Bill Clinton undid the reform when he raised the top rate to 39.6 percent.
Trump’s tax plan is being squeezed from two sides. If he doesn’t eliminate enough tax breaks, the debt will grow more rapidly. But if he — or his congressional allies — target too many tax breaks, he risks losing essential support. This suggests that, as the proposal winds its way through Congress, all the pressures will be to scale it back. The swamp will survive.