Economic Analysis



Op-Ed: How Much Punch Will the Economy Get from a Tax Cut

By Peter Morici, Ph.D.


Nov. 14, 2017 (Originally published in MarketWatch)

The House tax plan seeks to balance competing interests and would make the tax system fairer and boost growth, but both liberal critics and the administration are making terribly exaggerated claims.

The Tax Policy Center, headed by a former Obama administration official, charges the bill will benefit mostly businesses and the wealthy, while Treasury Secretary Steven Mnuchin and White House chief economist Kevin Hassett claim the plan will pay for itself by boosting growth to 2.9% and household incomes by $4,000 to $9,000 a year.

Increasing the standard deduction to $24,000 per couple would free the overwhelming majority of lower and middle-class Americans from tedious record-keeping and tax-code complexities, by permitting the vast majority to file the one-page short from.

Eliminating deductions for state income and most property taxes would end the terribly unfair practice of forcing a $35,000 year waitress in Virginia or Wyoming to pay higher federal income taxes to subsidize the preferences of rich Californians and New Yorkers for very expansive local government bureaucracies and much richer public employee pensions than the waitress will ever enjoy.

As for the administration, economists approach spending and tax cuts from two angles: the Keynesian demand jolt and supply-side incentives to invest – the “dynamic effects.”

Usual Keynesian multiplier

A $150 billion annual tax cut allocated equally between corporate and personal tax cuts (including the estate-tax reductions and lower 25% rate for some pass-through corporate income) would increase the demand for goods and services through the usual Keynesian multiplier.

We should expect a one-time boost to GDP of $180 billion $225 billion and $30 billion to $40 billion in new tax revenues. However, those estimates do not consider dynamic gains from encouraging more investment and permanently higher growth.

Other industrialized countries have been shifting tax burdens from businesses to individuals by leaning heavily on personal income and value-added taxes while slicing corporate rates. European families may get inexpensive health care and higher education, but they pay for those with higher personal taxes than their American counterparts.

Tax experts estimate U.S. effective corporate tax rates are substantially higher than elsewhere. For 2018, cutting the U.S. corporate burden by $75 billion would reduce the federal take by 20%.

According to estimates compiled by Hassett and R. Glenn Hubbard, that should boost corporate investment by 10% to 20% and, in the current environment of deregulation, it seems likely the overall benefit would be in the upper half of that range.

Labor productivity

If Congress approves, as is proposed, similar relief from the highest personal income tax rates for non-labor income from capital invested in pass-through corporations, a 20% reduction in taxes on profits overall could have significant consequences for labor productivity.

The economy is near full employment and with states raising minimum wages, business can be expected to devote most of the new investment to boosting labor productivity through robotics, computer software, worker training and better scheduling of work time rather than by adding to head count.

Workers would gain principally through opportunities to move to better jobs and earn higher wages but raising pay 7% to 15% as the president’s Council on Economic Advisers claims is a rather broad leap considering the expected jolt to gross domestic product growth.

During the recent recovery, labor productivity has advanced about 1% a year, and it seems reasonable to say that a 20% business tax cut would boost labor productivity and economic growth by about 0.2 percentage points.

During the recovery from the financial crisis, annual GDP growth has averaged about 2.2% growth and, with household balance sheets and business profitability continuing to improve, we could expect going forward perhaps 2.4% growth without any change in policy. The Trump tax cuts could reasonably be expected to permanently raise that to 2.6% on a long-term basis.

Conclusion

Overall the combined Keynesian and dynamic growth effects would boost tax revenues by about $85 billion.

Those estimates are not large enough to support the administration’s claim that tax cuts would finance themselves.


Editor’s Note: Peter Morici is an economist and professor at the Smith School of Business, University of Maryland, former chief economist at the U.S. International Trade Commission, and five-time winner of the MarketWatch best forecaster award. You can see his economic forecasts here.


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Op-Ed: The Flawed House Tax Bill — Will Not Promote Growth

 

Peter Morici, Ph.D.

 

Nov. 13, 2017 (Previously published in The Washington Times) –

 

The House Republican tax bill faces a tough climb to passage because it simply won’t deliver the kind of growth the administration claims and it distributes benefits unfairly.

It cuts the corporate rate from 35 to 20 percent but fewer than half of business profits are taxed through corporate returns. The balance is reported on personal returns through LLCs and proprietorships. Smaller firms would pay a special lower rate of only 9 percent rate but many larger professional service firms would pay a lot more.

After sorting through the exemptions and deductions that would no longer be allowed, corporations would effectively pay a marginal tax rate – the rate paid on additional profits as businesses invest to expand and create new jobs – of 20 percent, but many architects, physicians and other professional services firms would face substantially higher marginal rates – some higher than 35 percent.

This is terribly arbitrary and distorting – why corporations, which may never pay out profits to shareholders, or passive investors in real estate should pay lower marginal rates than professional service firms bears no justification in economics.

Stronger incentives

An architect that designs and manages commercial building projects is every bit as much a jobs creator as a firm that invests in apartment buildings, but the Republican tax bill affords the latter much stronger incentives to invest than many of the former.

Similar arguments apply for lawyers – who employ subcontractors for title searches, IT support and other services – financial planners, civil engineers and others.

Barring another recession, economic growth will pick up even if Congress does nothing – household balance sheets, stock market and conditions for U.S. sales abroad have recovered from the financial crisis.

Overall, White House Chief Economist Hassett estimates these business tax cuts would boost family incomes $4,000 to $9,000. Econometric research – including those published by Mr. Hassett before joining the administration – does not indicate these business tax cuts are large enough to further boost investment and growth enough to generate such gains.

Robbing Peter to pay Paul

The tax plan would cut personal income taxes by only about $300 billion. Although many families would get a tax reduction, much would be accomplished by robbing Peter to pay Paul. Higher tax bills would be imposed on other households by eliminating deductions for extraordinarily large medical expenses, slashing deductions for state and local taxes and mortgage interest, and eliminating deductions for student debt interest and some college tuition.

Some of that makes sense. Why should a waitress earning $35,000 in a low-income, low-tax state like Mississippi send money to Washington to subsidize the preferences of wealthy New York bankers for bloated city payrolls and richer public employee pensions than she can ever hope to enjoy.

A lot of it makes no sense at all. Why should young physicians, professors and other professionals – who incur huge debts to finance 7 to 10 years of training and low paid internships – not be given the kind of tax incentives as corporate training, executive retreats and client programs, which are often held at golf resorts for the veiled purposes of getting in 36 holes.

Higher education – like health care – is too costly and puts unconscionable financial burdens on students but taxing the victims more heavily is an awfully callous avenue to reform.

Real problem

The real problem is the lack of presidential and congressional courage. As originally conceived, corporate tax reform was to eliminate business interest deductions completely. That would have permitted applying the corporate tax to imports and generated more than $1 trillion to also reduce marginal rates on all small businesses and slash personal rates enough to give virtually everyone meaningful tax cuts.

Similarly, the president has repeatedly mentioned the need to repeal the carried interest loophole. That provision permits partners and employees in private equity firms, others on Wall Street and many corporate executives to disguise wage income as an equity investment and pay the lower 23.8 percent capital gains rate when the higher 35 or 39.6 rates should apply.

As with health care, the White House and members of the Republican majority bowed to special interests like big retailers and health insurers and came up with a defective bill. Don’t be surprised if the House tax plan ends up on the same scrap heap of history’s flawed ideas.

Editor’s Note: Peter Morici is an economist and professor at the Smith School of Business, University of Maryland, former chief economist at the U.S. International Trade Commission, and five-time winner of the MarketWatch best forecaster award. You can see his economic forecasts here.

 

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