When it comes to tax reform, the Trump administration has made it clear that its main goal is to simplify the tax code and cut taxes, but it has not offered too much in the way of specifics. In an August 30 statement, the White House indicated it would push for corporate and personal tax cuts, cut special interest loopholes, and overall simplify the tax code itself. While the argument for such reform is that it would stimulate economic growth, economists interviewed by the Business Journal explained that the real outcomes might be more complex than that.
“The Trump administration has advanced this tax reform plan that is basically cuts in taxes,” Robert Kleinhenz, economist and executive director of research for Los Angeles-based Beacon Economics, said. “The experience in the past with tax cuts has been that those [translate to] reduced revenue to the United States government. So if it advances on that front and then also pushes for heightened infrastructure spending to rebuild America’s infrastructure, I think the implication is that the administration doesn’t really care much about attending to the budget deficit.”
Daniel White, director of fiscal policy research for Moody’s Analytics, made a similar observation. “It doesn’t appear that deficit neutrality is something that they are interested in,” he said. In other words, the tax cuts being proposed would likely impact both the budget and deficit, he explained.
“Continuing to do the math, it doesn’t look like the current thresholds that have been laid out are enough to keep it deficit neutral, so a lot of it is going to depend on the details in terms of what preferential tax treatments are repealed and specifically what deductions and exemptions are repealed as part of any personal income tax reform,” White explained.
Kleinhenz said the Trump administration has indicated it may push for lowering the number of tax brackets. “It seems as though the idea or the upshot of that would be to really benefit higher income taxpayers more than anything else,” he said. “We’ve got to be mindful of the fact that when you take a look at where our income tax revenues come from at the federal level, something like half of the total tax collected comes from like the top 5% of taxpayers. . . .
“And therefore if one tries to reduce the burden on high income taxpayers and be revenue neutral, which is what the Trump administration intends to achieve, it almost undoubtedly has to come on the backs of middle income and lower income households,” Kleinhenz explained.
“You would be hard pressed to find many tax experts in the United States who don’t think that the tax code needs to be simplified and certainly overhauled,” White said. “But how you do that within the parameters of tax equity? Are you just getting rid of all the tax preferences for people in the low- and middle-income categories, or are you increasing tax burdens on higher incomes? That’s really the key there.”
White said many tax experts had been hopeful that the Trump administration would simplify the tax code and broaden the tax base while remaining revenue neutral. “They . . . seem to be sticking more to the supply side argument that if we cut taxes enough, economic activity will come to offset that. I don’t know that is the case and I don’t know that that is what will ultimately win over taxpayers,” White said.
Cutting the corporate tax rate to 15% is one of Trump’s more concrete proposals thus far.
“I think the biggest emphasis, especially from the Trump administration, is going to be on ways to lower the statutory corporate tax rate,” White said. “Any time you’re doing any type of tax reform, attempts to broaden the base and decrease rates are generally a good thing. So if we can get rid of some of the tax expenditures in the current corporate income tax code, that will help us lower that rate.”
Cutting tax breaks for certain special interests could be key in achieving this. “There are a tremendous amount of specific carve outs for special industries. For example, [the] oil and gas [industry] gets a significant amount of carve outs,” White noted. “That’s not necessarily in and of itself a bad thing. But if you’re able to lower overall corporate tax rates, especially versus other countries, then that can make the United States more competitive in terms of a corporate environment.”
Achieving such reforms is not likely to be easy, according to Kleinhenz. “As soon as you start talking about simplifying and eliminating deductions and tax breaks more generally, I think you will find that a whole variety of stakeholders will come out of the woodwork,” he said. “The reality is that we have got a very complex tax code with a lot of things that benefit different tax-paying groups in the economy. So that makes it difficult under any administration, not just the Trump administration to achieve the kind of tax reform that I think a lot of people would like to see.”
One of the biggest battles among legislators when it comes to corporate tax reform is likely to occur over the taxation of overseas profits, White speculated. When a firm brings overseas profits back the U.S., it is taxed at our corporate tax rate after already having been taxed abroad. “That is one of the reasons a lot of U.S. companies have a lot of cash sitting overseas,” White said.
“Do we allow those companies to bring it back into the United States at a reduced rate? Do we change the tax code going forward so that maybe companies are only paying taxes on profits that are earned within the United States?” White queried. “I think doing those kinds of changes and making sure that those changes are revenue neutral is going to be the biggest battle over the next several months, if we actually get to tax reform.”
In general, lowering corporate tax rates would allow companies to invest in their workforces and give raises to employees, purchase new equipment or property, or dispense more equity to shareholders – all outcomes that are good for the economy, according to White.
Still, he cautioned, “If we don’t do that in a deficit neutral manner and we are giving a lot of money from the federal government away to do that, that can significantly increase the federal deficit.” This could increase borrowing costs and “offset a lot of those economic positives from the lower tax rate, if not totally offset them.”
Kleinhenz cautioned that cutting and reforming taxes may not result in economic growth. “The idea that we would use tax cuts to trigger growth in the economy is a very tenuous connection,” he said. “Supply side economics and trickle down economics are terms that came about in the 1980s around the time of the Reagan tax reforms that made for marked changes in the tax code. But . . . since then, it has pretty much been established empirically that you can’t really jump start growth in the economy simply by cutting taxes.”
Trump has indicated he would like to grow the annual rate of increase in gross domestic product to 3% or 4% in part via tax reform, Kleinhenz noted. “As far as most economists are concerned, it’s just not possible to have growth of 3% or 4% on a sustained basis in the U.S. economy no matter what you do, because it is basically limited by our growth in the labor force,” he said.
“Our labor force has been growing by less than 1% over the last 3 years, and generally grows by no more than a percent even if you look at a longer time horizon,” Kleinhenz said. “So quite frankly, given recent performance of the economy, the growth in the labor force, the growth in productivity probably puts us at around 2% potential growth in the economy no matter what happens with the tax code.”
Both Kleinhenz and White were skeptical about whether tax reform will even be addressed by Congress this year.
“The only thing I would emphasize again is that you can’t overstate how busy Congress is going to be over the next three or four months,” White said. “And even if there was relatively broad political consensus on what needs to be done with tax reform, which there isn’t, it would be very difficult to get any major piece of legislation like that done before the holidays.”