plan that the Trump administration outlined on Wednesday is a potentially huge windfall for the wealthiest Americans. It would not directly benefit the bottom third of the population. As for the middle class, the benefits appear to be modest.
The administration and its congressional allies are proposing to sharply reduce taxation of business income, primarily benefiting the small share of the population that owns the vast majority of corporate equity. President Donald Trump
(pictured) said on Wednesday that the cuts would increase investment and spur growth, creating broader prosperity. But experts say the upside is limited, not least because the economy is already expanding.
The plan would also benefit Trump and other affluent Americans by eliminating the estate tax, which affects just a few thousand uber-wealthy families each year, and the alternative minimum tax, a safety net designed to prevent tax
The precise impact on Trump cannot be ascertained because the president refuses to release his tax
returns, but the few snippets of returns that have become public show one thing clearly: The alternative minimum tax
has been unkind to Trump. In 2005, it forced him to pay $31 million in additional taxes.
Trump has also pledged repeatedly that the plan would reduce the taxes paid by middle-class families, but he has not provided enough details to evaluate that claim. While some households would probably get tax
could end up paying more.
The plan would not benefit lower-income households that do not pay federal income taxes. The president is not proposing measures like a reduction in payroll taxes, which are paid by a much larger share of workers, nor an increase in the earned-income tax
credit, which would expand wage support for the working poor.
Indeed, to call the plan “tax
reform” seems like a stretch -Trump himself told conservative and evangelical leaders on Monday that it was more apt to refer to his plan as “tax
cuts.” Trump’s proposal echoes the large tax
cuts that President Ronald Reagan, in 1981, and President George W. Bush, in 2001, passed in the first year of their terms, not the 1986 overhaul of the tax
code that he often cites. Like his Republican predecessors, Trump says cutting taxes will increase economic growth.
“It’s time to take care of our people, to rebuild our nation and to fight for our great American workers,” Trump told a crowd in Indianapolis.
But the moment is very different. Reagan and Bush cut taxes during recessions. Trump is proposing to cut taxes during one of the longest economic expansions in American history. It is not clear that the economy can grow much faster; the Federal Reserve has warned that it will seek to offset any stimulus by raising interest rates.
At the time of the earlier cuts, the federal debt was considerably smaller. The public portion of the debt equaled 24 per cent of the gross domestic product in 1981, and 31 per cent in 2001. In June, the debt equalled 75 per cent of economic output.
The Trump administration insists that its tax
cut will catalyse such an economic boom that money will flow into the federal coffers and the debt will not rise. The Reagan and Bush administrations made similar claims. The debt soared in both instances.
Another issue: Both Bush and Reagan proposed to cut taxes when federal revenues had climbed unusually high as a share of the national economy.
Trump wants to cut taxes while revenues are close to an average level.
Since 1981, federal revenue has averaged 17.1 per cent of the nation’s gross domestic product, while federal spending has averaged 20.3 per cent.
Last year’s numbers were close to the long-term trend: Federal revenue was 17.5 per cent of gross domestic product; spending was 20.7 per cent.
Martin Feldstein, a Harvard University economics professor and a longtime advisor to Republican presidents, said that the moment was not perfect, but that Trump should nevertheless press ahead because the changes would be valuable.
“The debt is moving in the wrong direction,” Feldstein said. “But the tax
reform is moving in the right direction.”
Proponents of the plan assert that the largest benefits are indirect. In particular, they argue that cutting corporate taxes will unleash economic growth.
Trump’s plan is more focused on business tax
cuts than the Reagan and Bush plans, and economists agree that this makes economic gains more likely.
The key elements are large reductions in the tax
rates for business income: To 20 per cent for corporations, and to 25 per cent for “pass-through” businesses, a broad category that includes everything from mom-and-pop neighbourhood shops to giant investment partnerships, law firms - and real estate developers.
The plan also lets businesses immediately deduct the full cost of new investments.
“You’re going to get a boost in investment,” said William Gale, co-director of the nonpartisan Tax
Policy Centre. “It’s hard to argue that there won’t be a positive effect.”
But Gale added that there are reasons to think it would be modest.
The most important is that the economy is already growing at a faster pace than the Fed considers sustainable. “Economy roaring,” Trump tweeted on Wednesday.
Also, interest rates are low, and nonfinancial companies are sitting on $1.84 trillion that they don’t want to spend. “It’s not lack of funds that’s stopping companies from investing,” Gale said.
And the stimulus would come at the cost of increased federal borrowing. Interest rates might not rise if foreigners provide the necessary money, as happened in the 1980s and the 2000s, but that means some of the benefits also end up abroad.
It’s a venerable principle that lower tax
rates encourage corporate investment. But a study of a 2003 cut in the tax
rate on corporate dividends found no discernible impact on investment. The finding would not have surprised Bush’s Treasury secretary at the time, Paul O’Neill, who was fired for opposing the plan. “You find somebody who says, ‘I do more R & D because I get a tax
credit for it,’ you’ll find a fool,” O’Neill, a former Alcoa chairman, said at the time.
Trump’s plan also continues a long-term march away from progressive taxation. The federal income tax
is the centrepiece of a longstanding bipartisan consensus that wealthy Americans should pay an outsize share of the cost of government.
But successive rounds of tax
cuts have eroded that premise, according to research by the economists Thomas Piketty of the Paris School of Economics and Emmanuel Saez of the University of California at Berkeley. In 1980, the wealthiest Americans paid 59 per cent of their income in taxes while the middle 20 per cent of Americans paid 24.5 per cent. After the Bush tax
cuts, the wealthiest Americans paid 34.7 per cent of their income in taxes, while Americans in the middle income brackets paid 16.1 per cent.
Under President Barack Obama, Congress increased taxation of upper-income households. Trump is seeking to resume the long-term trend toward flattening the curve. Upper-income households would get large tax
cuts; lower-income households would get none. The exact impact on the middle class is not yet clear. The outline released Wednesday proposes new tax
brackets but does not specify income thresholds. It also proposes to replace the current tax
deduction for each dependent with a child tax
credit - but the administration did not propose a dollar amount for that new credit.
The administration said Wednesday that it was committed “to ensure that the reformed tax
code is at least as progressive as the existing tax
code.” That language, however, applies only to personal income taxes. The proposed reduction of business taxes and the elimination of the estate tax
would both disproportionately benefit wealthy Americans.
“I don’t think there’s any way to justify this as a progressive proposal,” said Lily Batchelder, a law professor at New York University who served as deputy director of Obama’s National Economic Council. “In broad brush strokes, they’re doing nothing for the bottom 35 per cent, they’re doing very little and possibly raising taxes on the middle class, and they’ve specified tax
cuts for the wealthy.”