Oliver Goodman, Managing Editor, JHU
As Donald Trump and his administration roll out their framework for tax reform, Americans are stuck on either side of an ideological divide that has existed in this country for decades. At the root of this divide lies a fundamental misunderstanding of the effect that tax policy has on the American economy. Trump’s new plan is rooted in conservative orthodoxy; his outline reduces the current seven tax brackets to three, cuts taxes for businesses and corporations, and eliminates the estate tax.
During a press conference in late September, top White House economic advisor Gary Cohn predicted the public’s response to Trump’s tax plan. Americans don’t care what happens to other people’s taxes, he assured—they only care about getting a cut themselves. Strictly speaking, the American public does not stand with Mr. Cohn. An ABC News/ Washington Post poll found that thirty-three percent of Americans were in favor of cutting taxes on the wealthy, while sixty-two percent were opposed.
This does not bode well for Mr. Trump’s framework, which repeals the estate tax, a move many Americans see as helping the wealthy. In fact, the current estate tax only applies to the top two-tenths of one percent of the American wealth distribution. Selling its repeal as a positive to the other 99.8 percent of Americans remains a harder feat for Cohn. That said, the estate tax is far from the centerpiece of Trump’s plan; it is demonstrative, however, of the ideological divide between the right and left on tax policy.
Trump’s framework is driven by the Republican theory of supply-side economics, which postulates that lower taxes stimulate growth in the economy. This is true—at least in theory. Cutting taxes increases incentives to work, save and invest, both on the part of corporations and individuals. Corporations who face lower tax rates see a spike in their revenue and hire more workers. Workers, in turn, face lower income taxes and should respond to that incentive by working more, increasing labor output in the economy.
The downfall of this tax plan is that it’s guaranteed to reduce government revenue, at least in the first few years of implementation. Because taxes are how the government collects money, a decrease in rates will drive down total revenue, which will have another profound impact on the economy: increased national debt. As government debt increases, interest rates will rise, and national saving will be reduced, cutting economic growth in the long run. Even as a concept, supply-side tax policies have unpredictable outcome.
This leads to the first massive divide in American politics: does supply side tax policy work? The answer to that is even more disputed. Historically, however, there are several examples that can be analyzed. In 2012, Governor Sam Brownback of Kansas drastically cut corporate taxes, promising a spike in GDP and job growth. The result? Kansas’s GDP grew at barely a third of the national rate, job growth lagged, and the state lost nearly four billion dollars of potential revenue.
The supply-side experiment in Kansas was calamitous failure. Proponents of tax cuts, however, don’t look to Brownback when citing historical examples—they look to Reagan. Indeed, much of the contemporary Republican economic strategy is based upon “Reaganomics,” even though Reagan’s policy successes and failures are much more difficult to extrapolate onto today’s economic climate than Brownback’s. First off, Reaganomics arose to combat the 1970’s issue of stagflation—limited economic growth with high inflation. The current situation is much different; growth is slightly below target levels, but so is inflation. In fact, one of the most perplexing dilemmas facing the Federal Reserve right now is how to stimulate growth without causing instability for inflation or unemployment.
The other fundamental misunderstanding of American tax policy is very simple: we don’t really know how high our taxes are. On September 6th, President Trump claimed over Twitter that America is the highest taxed nation in the world. Objectively this statement is false; US tax share as a percentage of GDP is 26.4 percent, almost twenty percent lower than countries such as Italy, France, and Denmark. Broad statements like Trump’s are easy to refute at a conceptual level, but more difficult to translate into practice, especially on an issue that only two percent of Americans believe is the most pressing for the country right now.
Disinformation and apathy can lead individuals to support policies that lack substance, especially when this source of disinformation is the current White House. Capitalizing on the fact that roughly one in five Americans believe that “economic problems” are the most pressing issue facing the country, the White House Council of Economic Advisors published a 14-page paper claiming that cutting corporate tax rates from thirty-five percent to twenty percent will increase average household earnings by $4,000 in four years and $9,000 in seven.
The non-partisan Tax Policy Center found a different conclusion when evaluating Trump’s framework. Using the dynamic scoring that White House economists had and accounting for GDP growth that these tax cuts would spur, the TPC found that Trump’s plan disproportionately favors wealthy Americans and will raise national debt by seven trillion dollars over the next ten years. Additionally, the average income increases that the White House predicts will be extremely regressive; households in the bottom two economic quintiles will see their after-tax income rise by less than one percent. For the next two quintiles, it’s less than two percent. For the top fifth of Americans? A 7.3% increase.
Despite the rhetoric of Mr. Trump and his administration, their framework for tax reform seems unlikely to catalyze a new age of economic growth. Rather, the White House must find a new way to escape a massive addition to the national debt, in wake of their health care plan’s failed attempt to pull billions out of Medicaid. Or the administration will be banking on a historically disreputable economic principle in a time of great uncertainty.