President Trump is willing to cut everybody’s taxes. Hooray. But that’s the easy part, and odds are slim such a tax plan could pass Congress if it blows a hole in the federal budget.
The spare outline of the tax plan Trump presented on his 97th day in office would slash corporate and individual income tax rates, in the hope that more cash in the hands of businesses and consumers would help the economy grow faster. That’s standard supply-side theory, which has never proved true in reality. As Trump’s team beefs up the plan and eventually presents it to Congress, budget hawks will insist on other measures to make up at least some of the federal revenue lost through cutting tax rates.
National Economic Director Gary Cohn, left, accompanied by Treasury Secretary Steve Mnuchin, speaks in the briefing room of the White House, in Washington, Wednesday, April 26, 2017.
As presented, Trump’s plan could add $5 trillion or more to the national debt over a decade. During Ronald Reagan’s tax-cutting presidency in the 1980s, the national debt rose by just over $1 trillion. With debt a much larger share of GDP today, there’s little to no headroom for tax cuts that could hasten a debt crisis and hike the portion of federal spending that goes toward interest payments.
So what to do? And what’s the point of cutting some taxes if you raise others, for no net gain to taxpayers? The idea of “revenue-neutral” tax cuts may seem confusing, but in reality there can be excellent reasons to shift the tax burden around, even if there’s no net tax cut, which is the same as no net addition to the federal debt.
A HIGHER SHAREHOLDER TAX
Trump wants to slash the corporate rate from 35% to 15%, which is appealing because it would encourage more companies to do business in the United States. It would also kill a lot of federal revenue, of course. One way to offset the budgetary damage would be to tax capital gains and dividends at the same rate as income–39.6% for top earners–instead of the lower rates on the books now, typically 15% or 20%. This combination of changes would fix a few major distortions in the corporate tax code. Research by economists Alan Viard of the American Enterprise Institute and Eric Toder of the Tax Policy Center suggests such a plan could substantially improve business performance while adding little or nothing to the debt.
Sure, there would be complexities, such as figuring out whether to impose the tax every year, on an ongoing basis, or only when shareholders sell an asset. But there are complexities throughout the tax law, and this setup might end other complexities. Lowering the corporate rate would draw a lot of profits held overseas by US companies back to the United States, for instance, and probably end “inversions” in which US companies move their headquarters to another country where taxes are lower. It might even lure more foreign companies to the United States.
A VALUE-ADDED TAX
Economists also like the value-added tax as another way to raise revenue. Most developed countries have a VAT, which is typically levied across the board on a wide range of products and services when consumers buy them. A VAT is a tax on consumption, which raises prices and gives consumers a reason to buy less. That sounds bad. But our current system primarily taxes income, which is arguably worse, because it creates a perverse incentive for some people to work less. If income taxes were lower and consumption taxes higher, there would be incentives for people to work more (and earn more), while spending less. And if people earned more, they might spend more anyway. That would generally boost growth.
The value-added tax is unpopular on Capitol Hill, because it sounds like a national sales tax, which conservatives strongly oppose. Still, the tax plan backed by House Speaker Paul Ryan includes a similar measure, called the border-adjustment tax, or BAT. Like a VAT, the BAT (sorry for the jargon, it’s a tax thing) would shift taxation away from income, toward consumption and production. It would also raise around $1 trillion in revenue over a decade, allowing tax cuts while keeping the debt stable. Trump, however, isn’t a fan of the BAT, which is complex and hard to explain. And voters may be understandably leery of a new tax that has never been tried in the real world, even if they know it comes with a tax cut elsewhere.
LESS FOR THE 1%
One other thing Trump could do is simply abandon the tax cuts he favors for the 1%, while sticking with the cuts for businesses and ordinary workers. His plan now is to cut the top individual rate from 39.6% to 35%, lower capital gains taxes, and eliminate the estate tax (which Republicans call the “death tax”). One can reasonably ask: why? All of those changes would benefit the wealthy almost exclusively, and they’re the last people who need help. In fact, the whole problem of worsening income inequality—which contributed to Trump getting elected—arises from the fact that the top 20% or so have been getting ahead, while the bottom 80% or so have been falling behind.
Besides, if a cut in business taxes went through, it would benefit the wealthy anyway. They’re the ones who typically own stocks—which would rise if taxes fell and profits rose—along with many of the privately owned “pass-through” businesses that would also keep more income if tax rates fell. Plus, withdrawing yet another tax break for the wealthy would improve Trump’s cred among middle- and working-class Americans who don’t see how more money in the pockets of fat-cats would trickle down to them. And keep a bit more money in federal coffers.
