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The real and unreal in Trump’s tax plan

Tax observations:

  • The burden of the corporate income tax—surprise—really does fall mostly on corporations and their owners, rather than being passed along to consumers. Hence, cuts in this tax—just plain cuts—are likely to increase the after-tax income of the wealthy much more than middle class or poor people. This must be kept in mind by readers of what follows, as theories exist claiming the reverse.
  • Among the ideas that make sense in the Washington tax reform effort now going on a border-adjustment for the the corporate income tax in the proposed Congressional plan that levels the playing field among countries that produce for the world market by moving toward taxing commodities where sold, rather than where produced. Along with the inter-national tax equity justification, such a move would have an export-promoting tendency in a world where trade deficits matter.
  • For moderate- and low-income households, the proposed doubling of the standard deduction is probably the key offering in the tax plan. It will not help the poorest of the poor. To its credit as a helper of moderate-income taxpayers, this provision would help renters, who tend to be poorer than homeowners and lack the ability to benefit from provisions that allow homeowners to deduct mortgage interest. For those who have no taxable income to offset, deductions do not help, of course. Only refundable credits help such taxpayers; these are unfortunately unlikely to be proposed by a Republican president, even one billing himself as a populist. Relief to low-income people that might be more acceptable might come in the form of a refund of some Social Security (“payroll”) taxes for people with very low earnings but very low or no income tax liability to hack away at.
  • Mainstream contributors to the New York Times for example attack (1) the lack of realism of high-end tax cuts that supposedly increase growth enough to pay for themselves—the main supply-side economics argument for business-oriented tax cuts and (2) any measures that lead to a higher projected pathway for the federal debt, which they regard as ruinous and unnecessary in light of what they see as a complete recovery from the Great Recession.

I will focus in the rest of this post on the last point above. Concern (1) is more or less right, though tax cuts of any kind are likely to have some positive effect on demand, which in turns supports the “derived demand” for labor.  Tax-cut concern (2), however, seems incorrect to me; it is not true that the need to expand the economy is now over. Rather, a supply of unemployed workers is being maintained in an inefficient and misguided policy to keep inflation under control.  Better means to effect the latter end exist. Confirming concerns about economic growth is the news that the first-quarter number has come it at an anemic .7 percent.

An otherwise somewhat reasonable analysis of the tax plan by Steven Rattner—also in the NYT—implies that rising debt is a disaster, without making any case whatsoever that there is an economic cost of federal deficits as such. A letter to the editor in a page of comments on the issue (link to letters section) makes an irrelevant analogy to the case of a state, where budgets must be kept (with a few exceptions) balanced by law. There, a big tax cut must inevitably and unfortunately be followed by spending cuts on education, law enforcement, or other substantial budget items at that level of government. Hence this letter also provides no statement of well-founded negative consequences of federal deficits or debt per se. (Of course, high enough, they can reek havoc by sending demand for goods and services through the ceiling.) (An aside: There is no special reason why I focus on Rattner’s article or others in the same newspaper; the articles that I mention represent widely held views in the current tax debate.)

The economic problems following the Reagan tax cuts would appear to flow in large part from Federal Reserve decisions to drastically increase the federal funds rate, which rose to more than 10 percent, helping to cause a deep recession that technically lasted from 1981-82. The deficits, on the other hand, almost certainly helped to unleash an economic boom after the recession ended, rather than in some unknown and obscure manner reducing growth (despite their badly flawed supply-side rationale). On an optimistic note, while the Fed plans to increase interest rates following any big Trump tax cuts to offset their potential to stoke inflation, it is likely to be more gentle this time.

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