Magical thinking will not save Trump’s tax plans
   
The Republican party’s sums on revenue and debt simply do not add up


© Zebedee Helm


Americans love government programmes but hate taxes. Over the past 40 years, Republicans have catered to these opposed preferences with magical thinking. They cut taxes but not spending, raising deficits in the process — exactly what conservatives promise not to do.

Donald Trump is no exception. He promises a cut in corporate tax from 35 per cent to 15 per cent, along with a one-off lower tax rate to induce US companies to repatriate more than $2tn in profits held overseas. The top individual tax rate would also be cut from nearly 40 per cent to 33 per cent.

What the president has presented is not a tax plan so much as rough principles around which the administration can negotiate with Congress. Even so it is striking that Mr Trump has offered no substantive loophole closures, let alone spending cuts, to help pay for his proposals.

The result, according to the Tax Policy Center, will cost the government about $2.4tn over the next decade. This is politically unpalatable to Republicans, who have pledged to support only revenue neutral tax reforms.

The administration — channelling Ronald Reagan’s adviser Arthur Laffer — says tax cuts will create economic growth, offsetting the fall in revenue. While the cuts should provide a temporary demand stimulus, there has been little evidence in the past 20 years that tax cuts sustainably boost growth. Tax cuts in 2001 and 2003 during George W Bush’s administration did not jump start growth. Neither did Obama-era cuts. Yet in 1990, when President George HW Bush raised taxes, gross domestic product growth went up for five years. Bill Clinton’s presidency included tax rises and strong growth. History has not been kind to Mr Laffer’s ideas. There is no alchemy in which tax cuts pay for themselves.

A reduction in taxation without spending cuts, on the other hand, always creates deficits. In this, the Trump proposals resemble Reaganomics on steroids. Mr Reagan came to office promising small government and low taxes. He passed both tax cuts and tax reform, closing many loopholes. But he spent so much that the deficit doubled as a percentage of GDP during his first term. He sopped up some of the red ink with higher business, payroll and energy taxes.

Mr Trump would increase the deficit again, at a time when the overall public debt burden is much higher. It would also set up a conflict with the Federal Reserve, which is likely to respond to a runaway deficit with rate increases.

The image of an American economy groaning under heavy tax burdens is not accurate in any case. US taxes are low by historical standards and compared to other rich nations. All levels of government — federal, state and local — collect about 26 per cent of national output in tax. In prosperous Germany the figure is 37 per cent.

If growth does not improve before the 2018 midterm elections, the Republicans risk losing control of Congress. Ideally, cutting corporate taxes would lead to higher capital investment and spur an expansion. Well-targeted tax cuts can indeed have this effect. Broad reductions in the headline rate often do not. In the 1950s, the top marginal tax rate for individuals was 90 per cent and the corporate rate was over 50 per cent. Today, it is roughly 35 per cent in both cases.

Many individuals and companies take advantage of loopholes to pay far less. Yet both real GDP and real per capita GDP were growing more than twice as fast in the 1950s as in the 2000s. As Warren Buffett points out, people invest when they think they can make money, not because of tax rates.

A one-off lower tax for repatriation might bring a large chunk of the overseas cash back to the US. Yet after the last initiative in 2004, much of the money that returned went to share repurchases, not investment. If that happens again, it may shore up the markets, but not the real economy. If cut-rate repatriation is allowed, companies should be forced to show that they are using a significant portion of the funds for capital investment.

Republicans promised throughout the 2016 presidential campaign to cut taxes and trim the deficit. But their first attempt to reform tax via a repeal of Obamacare (in essence a tax cut disguised as a health proposal) failed. Now, the president has proposed to balloon the deficit in an unproductive way. He is looking ever more like a conventional, trickle down conservative.

No amount of magic can change the fact that his budget sums do not add up.

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