This article looks at Donald Trump’s tax plan in the context of current proposals.
His election victory, and the Republican control of both houses of Congress, means that there will be tax cuts, mostly for businesses and the rich, and there will be deficits. There’s nothing wrong with deficit spending. Everyone, please, get a grip!
Having dollar as the world’s reserve currency permits the United States to have the luxury of constantly tinkering with the tax system and using it as a giant system of rewards and punishments. It’s the exorbitant privilege, tax version.
We don’t tax for revenue. Spending is not constrained by tax collections. The government is not a household with a budget. Deficits don’t matter. The government can create dollars to spend on whatever Congress wants. Compared to other Western governments, the US government taxes at a very low level, about 18% of GDP.
The government puts money into the economy by means of spending and tax cuts, and removes it by taxation. Sometimes the government wants to remove money to prevent asset bubbles and redeem the currency. That being said, tax cuts are subject to arbitrary congressional budget rules that say that every tax cut has to be offset by a tax increase of spending cut somewhere else.
Government accounting is cash-in, cash-out. Self-imposed congressional budget rules require that tax cuts be “paid for” by offsets in the context of pure tax bills. The rules are looser for spending reconciliation bills, which allow spending cuts as offsets and only require a bare majority approval in the Senate. Expect congressional Republicans to use budget reconciliation as the vehicle for tax changes.
Why can’t Congress just change the budget rules? Because changing them would require a 60% majority vote that the Republicans don’t have. Perversely, Democrats have become the party of balanced budgets because of their Wall Street connections. Congress made the budget rules in 1984, in the wake of the Reagan tax cuts, specifically to constrain tax cutting.
Leaving aside deficit fusspots, Wall Street cares about deficits because deficits affect the prices of debt securities. The bondholder class doesn’t like actions that reduce the prices of any debt securities, federal or otherwise. And they are powerful—not for no reason did James Carville say he wanted to come back from the dead as the bond market.
The bond market duly had a hissy when Trump was elected. Trump is being called the inflation president, with the name-callers forgetting that inflation isn’t serious until there’s wage inflation—of which there is no indication.
Trump’s tax cutting will be accomplished in a hurry. House Republicans, who have a bill in concept, and plan to take action within the first 100 days of a Trump administration. This makes strategic sense; the president’s first months are the window for getting things done. Presidents don’t get much else done after their first two years in office.
Trump’s plan, which has huge tax cuts for business and the rich, emphasizes growth. It would inject $4-6 trillion into the economy over 10 years, mostly by means of business tax cuts. This would be supply-side economics, which you can do with your own currency. Two problems:
First, tax cuts would have to be enormous to have any macroeconomic effect on a $16-18 trillion economy. His first plan proposed even larger cuts, and the deficit hawks swooped. Think of it as the tax version of QE. But consumption has fallen, and newly subsidized businesses would still need customers in order for investing to make sense.
Second, even if enhanced growth were achieved, it would not be evenly distributed. US income taxes are progressive. Spending is not, so the system as a whole is not redistributive. And as the individual discussion shows, it would not put a lot more money in the hands of people with a high marginal propensity to consume.
There is some original thinking in the Trump business tax plan, but its revenue cost distracts from the ideas being propounded. Trump wants to cut the corporate income tax rate by more than half, to 15%, and make that available to the half of all US businesses that are not in corporate form.
It is not clear, but he might also be proposing an elective tax determination for partnerships to enable their owners to take advantage of the 15% rate for undistributed income. The House Republicans’ tax plan calls for entity-level determination of partnership taxable income, with an imputed deduction for salaries. It’s not clear the whether either plan would involve an entity-level tax, although that would be the cleanest way to do it.
Although a lower rate for these mostly private businesses raises fairness concerns, data developed by the US Treasury show that the owners of partnerships pay very low effective rates under the current system. Progressive taxation is important to maintain an appearance of fairness in the economic system.
Under Trump’s plan, businesses would be able to choose between expensing of equipment or a net interest deduction. This would represent a move toward a VAT-like cash flow tax for business taxpayers. It might be limited to manufacturers. The idea is to make the United States more attractive.
The House Republicans have proposed the destination-based cash flow tax would work like a subtraction method VAT. It would be a cash flow tax because capital equipment expenditures could be immediately deducted in full. Intellectual property, research and wages costs would also be fully deductible. This plan, which would be a sea change in corporate tax policy, is likely to be the starting point for Trump business tax cuts.
With the aim of encouraging US employment, the cash flow tax would permit a deduction for domestic wages, making it resemble an income tax. It would not permit any deduction for foreign wages or foreign production inputs. How could the tax administrator differentiate, when production is carried out piecemeal in several countries?
That’s not clear from the House Republicans’ plan description. The plan might perversely send more production to China, the world’s manufacturing plantation, which is not a low-tax country. The result would be a quasi-tariff in the amount of the corporate tax rate on imported goods. An exporter could have a US tax liability of zero. It would be trade policy achieved through the tax system.
The trouble with this plan is that it isn’t a VAT, and it wouldn’t satisfy the WTO trade agreements the United States signed. The Europeans would argue before the WTO that the cash flow tax contained an illegal subsidy for exporters and effectively operated as an import tariff. Exporters could deduct domestic wages and importers couldn’t deduct foreign wages. That would be illegal discrimination in favor of exports. There are theorists who think that Congress might deliberately set up a WTO violation in order to be told to adopt a VAT instead.
The House Republicans also propose a European territorial dividend exemption system for the benefit of a handful of large businesses like Apple, Google and Big Pharma. Trump did not embrace that system, which is more suitable for small open economies. The United States is a large, mostly closed economy, whose companies primarily sell to Americans.
But Trump would allow these companies to pay untaxed deferred foreign income to shareholders as dividends at a lower tax rate. Trump proposes a deemed repatriation at a 10% rate for cash and 4% for earnings not represented by cash. In revenue calculations, repatriation is represented as an immediate revenue fillip.
There’s not much juice in Trump’s tax plan for middle-income households. That’s because there’s not much more cutting that can be done. Middle class people don’t pay a lot of income taxes individually. They pay a lot of income taxes collectively. They pay a lot of payroll taxes, which would not change.
According to the Urban-Brookings Tax Policy Center, a look at a household of married parents and two young children with an $82,000 income shows that they currently pay $6300 in payroll taxes (not counting the employer’s equal share) and $4000 in income taxes. Trump’s would reduce the latter to $3500. So we’re talking an additional $40 per week in their paychecks—two bags of groceries. It’d be a gesture.
What Mitt Romney said about 47% not paying income taxes was true. That’s because George W. Bush’s administration presided over a broad tax cut that removed people at the lowest end from the income tax, and cut middle class taxes, all to justify cuts at the top end. The Obama administration preserved all these cuts—which were essentially booby-trapped in that it was hard to remove the cuts at the top end without also raising taxes at the low end.
Trump would have individual rate brackets of 12, 25 and 33%–the latter being a tax cut at the top, but it would kick in at a relatively low level. He would repeal the AMT. Some people would be in higher brackets, offset by an enlarged standard deduction ($15,000), under which 60% fewer people would itemize (few do already). Itemized deductions would be capped.
Trump would repeal the estate tax. Instead his plan would tax capital gains at death—a highly unusual proposal that has not been taken seriously before. His exemption would be very large, around $10 million.
Trump would tax investment fund managers on profits interests as regular earners. Trump would repeal the special 4% add-on tax substitute for Medicare taxes. These managers would benefit from his lower business rates for partnerships.
Trump has said he would repeal all taxes associated with Obamacare, which presumably would include the penalty for not buying insurance.
Our child credit is very complicated. The taxpayer has to be the custodian of a qualifying dependent (child under 13). There is a reduced percentage of credit—starting at 35%–for every $2000 increment of income over $15,000. Care expenses have to be employment-related. Then there is a $3000 per head limit on the qualifying expenses, capped at the lowest earner’s income. Employer-provided dependent expenses must be subtracted. Payment to family members is not creditable.
Roughly 20% of all children live in poor households that don’t owe income tax. When the child credit was created, the Republicans wanted to limit it to people who owe income tax. It is still nonrefundable, unavailable to poor parents. It is also geared to professional child care, so Republicans want to extend it to stay-at-home mothers.
Trump would offer an alternative to the credit in the form a nonrefundable above-the-line deduction for up to $5000 of child care expenses, and a capped child care rebate for EITC households that don’t owe tax. The deduction would be capped by state for the average cost of care. There would be relatively high income limits and phase-outs for the deduction as well. Trump’s proposed elimination of head-of-household filing status and personal exemptions could erode the benefit of the child care deductions.
Trump would also provide tax-favored savings accounts for child care expenses to which $2000 per child may be contributed annually. The government would match $1000 per year of contributions. Deductions and tax-favored savings accounts appeal to better-off parents.
Trump is not proposing to cut parents a big check to help them take care of their children. Yet in other Western democracies, child benefit is $3000-5000 per child. It is done as direct spending, distributed on a monthly basis and available to all households. Those countries are trying to encourage childbearing; most have less than replacement birth rates. They also have regressive tax systems and progressive spending; the United States has the opposite.
Courtesy : Forbes.com