Tag: Tax Reform

How Can Republicans Entrench the Tax Cuts?

The peculiarity of Congressional 10-year budgeting has left its mark on the tax debate. In the UK, if something like the Republican bill had passed, it would be regarded as a significant tax cut, pretty much across the board. And rightly so.

As JCT analysis has shown, in 2019, 44 percent would see tax cuts of more than $500, 17 percent tax cuts between $100 and $500, with just 8.1 percent seeing tax increases greater than $100. Even by 2025, just before most of the individual income tax cuts would expire, 56 percent would see tax cuts of more than $100, with just 13.5 percent seeing tax increases of $100 or more. And this includes as “tax rises” the reduction in subsidies paid out as the removal of the individual mandate penalty leads to fewer people opting for health insurance.

As Chris Edwards has explained, even on the JCT’s own figures (which attribute most of the burden of corporate income taxes to the rich), the biggest financial winners in terms of a reduction in the proportion of federal income and corporate taxes they bear will be the middle-class.

SALT Deduction Changes Could Improve State Tax Systems Too

Thirteen law professors have written about how the GOP tax plan will provide incentives for tax planning and behavioral changes that might undermine current revenue estimates.

The document, “The Games They Will Play: Tax Games, Roadblocks, and Glitches,” is clearly written by professors skeptical of the overall tax package. But it provides useful examples of potential problems, such as ways new passthrough provisions could lead to complex battle lines between tax authorities and taxpayers.

It also assesses how the elimination of the state and local income and sales deduction (SALT) from the federal income tax code might encourage changes to state tax systems. Remember both House and Senate Bills would only retain a deduction of up to $10,000 for property taxes.

The restriction of the SALT deduction will, ceteris paribus, raise the cost of state and local government expenditures for affected taxpayers, particularly in higher-income, higher-tax jurisdictions. That might be expected to put pressure on states to reduce spending—a feature of this reform, rather than a bug.

But according to the professors, states may also seek to “reshape their tax systems so as to respond to this change and retain the benefit of the deduction for their taxpayers.” One means is to shift towards collecting more revenue from deductible taxes.

How might they do so?

One way for states to achieve this is by shifting to use of the property tax. The liquidity impact on taxpayers of a shift to property taxes can be mitigated by circuit breakers administered through a state’s income tax—essentially, reducing income tax liability in exchange for higher property taxes. Such responses would effectively allow taxpayers to deduct the full amount of state and local property and income taxes, up to the $10,000 cap.

Now, the professors paint this as a bad thing, because they believe it means federal revenue losses from tax reform will be greater than currently projected. From an economic perspective though, property taxes are broadly regarded as being less distortionary to economic decisions than income taxes. They also tend to encourage localism, and given they are widely disliked (particularly by elderly constituencies who turn out in elections), may be even more effective at bringing attention to the scale of state government spending than an increased income tax burden.

Whilst it would be better to have no SALT property deduction at all, if a consequence of tax reform is states using property taxes instead of income taxes, then that could be a good thing for the economy.

Kevin Hassett Updates Adam Smith

The chair of the White House Council of Economic Advisors, Kevin Hassett, visited Cato last week to talk about tax reform. Under Kevin’s leadership, the CEA has produced two reports discussing how corporate tax cuts can boost wages and growth.

The CEA explains the basic mechanism:

reductions in the corporate tax rate incentivize corporations to pursue additional capital investments as their cost declines. Complementarities between labor and capital then imply that the demand for labor rises under capital deepening and labor becomes more productive. Standard economic theory implies that the result of more productive and more sought-after labor is an increase in the price of labor, or worker wages.

And discusses how lower taxes attract investment from abroad:

One component of investment is foreign direct investment (FDI), and numerous empirical studies … have observed that FDI is highly responsive to cross-border differences in tax rates.

And describes how high corporate taxes hurt workers in the global economy:

The fact that capital can move relatively easily across borders while labor cannot serves to intensify the burden of the corporate tax on workers.

Essentially, the CEA studies update Adam Smith with new empirical data. Writing in his Wealth of Nations, Smith described how heavy taxes on mobile “stock,” or capital, in a world with open borders would cause losses to workers and the broader economy:

Secondly, land is a subject which cannot be removed, whereas stock easily may. The proprietor of land is necessarily a citizen of the particular country in which his estate lies. The proprietor of stock is properly a citizen of the world, and is not necessarily attached to any particular country. He would be apt to abandon the country in which he was exposed to a vexatious inquisition, in order to be assessed to a burdensome tax, and would remove his stock to some other country where he could either carry on his business, or enjoy his fortune more at his ease. By removing his stock he would put an end to all the industry which it had maintained in the country which he left. Stock cultivates land; stock employs labour. A tax which tended to drive away stock from any particular country, would so far tend to dry up every source of revenue, both to the sovereign and to the society. Not only the profits of stock, but the rent of land and the wages of labour, would necessarily be more or less diminished by its removal.

Today, people have much greater ability than in Smith’s time to move their capital across borders, and so taxes on capital are more damaging than ever.

Veronique de Rugy and I discussed these issues in a 2002 paper on international tax competition. Fifteen years later, it is gratifying that Congress may finally make reforms to attract capital rather than repel it.

Ryan Bourne: Corporate Tax Cut will Help Workers and Shareholders

In case you missed it over the weekend, Cato scholar Ryan Bourne wrote about the Republican tax reform plan in an op-ed featured in The Hill. He responds to the argument that corporations will use money saved from the reduction in the federal corporate tax rate to increase dividends, buy back shares, or other strategies that benefit their shareholders. 

Major companies, including Cisco Systems, Pfizer and Coca-Cola, have said they will use most of the gains from proposed corporate rate cuts to increase dividends to shareholders or buy back their own shares. This has been reported and shared on Twitter as a slam dunk against the Republican tax plan.

After all, a major claim of the administration has been that corporate rate cuts would benefit workers through wage rises, rather than flowing exclusively to capital owners.

Yet, the reaction of these companies is nothing unexpected, at least in the short term. Any substantial cut to the corporate rate provides an immediate windfall to so-called “old capital.”

But even though the initial beneficiaries of changes in the corporate tax rate will indeed be corporate shareholders, Bourne points out that those savings have to go somewhere. 

If existing firms have excess capital in the short-term, distributing it to shareholders in some way makes sense. This money is unlikely to sit dormant afterwards. In all likelihood, that money will be deployed elsewhere to find new value.

The market for growth industries through venture capital and angel investment is huge, and these windfalls can be invested in the start-ups and industries of the future.

The key point though is that the lower corporate rate improves the after-tax profitability of investment across the economy, and as such generates new activity. Other things given, domestic companies will have greater incentive to invest.

Foreign companies will be more likely to expand their investments in the U.S. — or even shift their operations here. U.S. companies will repatriate profits earned by their foreign subsidiaries rather than leaving them abroad, and more capital will flow from other less productive U.S. sectors into the U.S. corporate world. 

Read the op-ed here

A Tax Bill Provision Only Athletic Directors Could Hate

It’s obviously too early to spike the football, but there is a provision in both the Senate and House tax bills that everyone should be able to endorse, except maybe colleges and their athletics departments: eliminating the 80 percent federal tax deduction college sports season ticket holders get when they pay “seat license” fees—often called “charitable gifts”—charged by schools. It’s an absurd deduction that I’ve complained about periodically, and it’s nice to see it targeted for elimination. And in case we need a reminder that this deduction has zilch to do with the “public good” that higher ed so often gives as its excuse for every special treatment it demands, USA Today has reported that this season 12 big football schools alone are on the hook for at least $70 million to buy out fired head coaches. Sounds like a lot of private good there.

These days it seems like we on Team America can’t agree on anything, but we all ought to agree on this: the seat license deduction must go.

Problems with a “Fiscal Trigger”

Fiscal rules can theoretically improve policy by eliminating “time inconsistency” among lawmakers. But the proposed fiscal trigger being discussed in the Senate tax reform bill would be a terrible fiscal rule.

You can see the thinking. Several senators worry about tax cuts blowing a big hole in the public finances. If they do not have the desired impact on economic growth, resulting in less revenue than expected, the budget deficit will grow and drive the national debt even higher. Concerned senators therefore seek a mechanism whereby if revenues are lower than expected, tax cuts will be partially reversed.

It’s welcome that some senators take the US federal government’s burgeoning national debt seriously. But there are obvious flaws with this plan (though we do not know details as yet), some of which have been discussed widely already.

First, how exactly will deviations in revenues be judged? An economy is a complex organism, and it is difficult to disentangle how much any change in revenue relative to forecasts is due to changes in tax rates as against other factors. Just look at the debate in the UK. Last week, the Daily Mail newspaper published a report that tax receipts following corporate tax cuts there had been much higher than expected. But experts from the Institute for Fiscal Studies pointed out that much of this was due to a faster recovery of corporate profits in the financial sector and the effects of Brexit, which had little to do with the changing rate. Under a trigger which merely judged revenues against forecasts, a host of things that affect revenues (both upwards and downwards) could be chalked up as the effects of tax policy, potentially resulting in damaging tax rises.

Then, as J.D. Foster notes, there are likely to be other tax policy changes and changes in growth forecasts in future years too. How will these be disentangled and the effects of this specific Act isolated? Will the trigger apply to just a particular revenue stream, such as corporate income tax revenues, or more broadly to capture all the spillovers of any investment boost? If the former, the probability that the trigger will be activated is highly dependent on the accuracy of any analysis of the incentives to incorporate versus operating as a passthrough. In other words, there are huge unknowns here.

Lots for Economists to Like in the House GOP Tax Plan

Debating the implications of the GOP tax plan, most analysts speak past each other. That’s because there are 3 prisms through which changes can be assessed: the implications for efficiency and growth, the impact on the public finances, and the distributional impact across income groups.

The media tends to focus on the latter, but this is the least interesting. Distributional analysis tends to put the status quo on a pedestal (see how “progressive” sources now defend the state and local income tax deduction), tends to be static in its thinking, and in the case of this tax reform, ignores the potential for significant corporate income tax rate cuts to raise wages. Added to that, a lot of the results are simply not surprising. Given a large proportion of people do not pay income taxes, it is hardly shocking that their after-tax income doesn’t increase following income tax rate cuts, though this can be influenced of course by credits.

As my colleague Chris Edwards has written before, the GOP open themselves up to these distributional critiques by talking about how their changes represent a “middle class tax cut” rather than focusing on the supply-side case for lowering marginal rates. As a result, this morning’s tax discussions on Twitter have been dominated by the sharing of blogs saying, in essence, that “the tax cut is actually a tax increase for much of the middle-class because the new credit is set to expire in 2022.” I am struggling to find blogs or comment pieces which used the same logic to explain why George W Bush’s temporary tax cuts weren’t really tax cuts at all, but hey, who expects consistency in politics!

On the efficiency and growth front, there is in fact lots to like in the House GOP plan. The changes to the income tax code stripped away a whole host of small deductions and made significant inroads into some big ones too (curtailing the mortgage interest deduction and eliminating the state and local income tax deduction), as well as abolishing the AMT. Of course, to make this politically palatable, the GOP near-doubled the standard deduction, expanded the child credit and added a new personal credit too. These will do little for growth, especially compared with purely lowering marginal rates, but they do help compensate losers from other changes.

The long-term consequence of the package of these reforms though (assuming they pass Congress without being further diluted) will be a combination of lower rates, fewer deductions and fewer people itemizing. This will significantly reduce deadweight costs associated with taxation. A key variable to watch out for to assess the broader economic impact of the income tax changes is the proportion of people who will face lower or higher marginal rates as a result of all the changes. One reason why this must be seen in the round is that linking tax thresholds to chained CPI rather than CPI will see slower threshold increases, meaning people being dragged into higher bands more quickly as nominal wages rise over time.

The most important policy goal was of course a large permanent cut in the corporate income tax rate, and this plan (if it passes) would achieve that. There is good reason to think this will raise the level of GDP and wages. Even though non-corporate businesses were already favored in the tax code once you include taxes on dividends, the GOP wanted to cut all business tax rates and broadly maintain differentials. They therefore introduced a new pass-through business tax rate at 25 percent. But this necessitates complex anti-avoidance rules to stop people restructuring their affairs to earn less wages and more business income.

The other, final change of note is the welcome planned repeal of the estate tax. This will not set be fully implemented until 2024, however, by which time the political landscape may have changed significantly.

Overall then, critics of the plan were wrong to say this was just about tax cuts without reform. In fact, the plan was a lot bolder on making changes to deductions and the structure of the code than many expected. Sure, other less growth-oriented measures were included to compensate some of the losers from broader reform, but overall the tax code is made more coherent.

The real debate for conservative economists should be weighing these efficiency gains against the consequences for the public finances. The plan is projected to add $1.5 trillion to the debt over 10 years, but even this is predicated on full expensing and the new income tax credits expiring after 5 years, which is debatable to say the least. The problem is that absent spending cuts, net tax cuts ultimately become tax shifting, leading to higher taxes in future.

A few weeks ago, I wrote that tax cuts which raised borrowing were worth it if they were used to grease the wheels of pro-growth tax reform or if they were a precursor to restraining spending. The latter looks unlikely. Whether the specific tax changes the GOP have planned got enough “bang for the buck” from the extra borrowing is an open question. Certainly, the priorities as this develops into legislation must be to keep the most economically beneficial measures: the corporate rate cut, the marginal income tax rate cuts, and the elimination and constriction of deductions.

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