Can We Afford This? Analyzing President Trump’s Tax Plan, Part I

Can We Afford This? Analyzing President Trump’s Tax Plan, Part I

Image Source: staticflickr.com

Image Source: staticflickr.com

Corey Uhden, Politics Contributor

The Trump White House has unveiled a very brief outline of their principles for tax policy: cutting taxes to stimulate economic growth of 3%, so what are some of the considerations behind pursuing pro-growth tax reform at this time?

Part I of this series will focus on recent experiences with pro-growth tax cuts. Part II will consider President Trump’s proposal, its potential impact on the economy, and its implications for the federal budget.

The ostensible purpose for cutting the corporate income tax rate to 15% is to make the country’s economy more competitive in the race for global capital. Trump has also proposed allowing limited liability corporations that currently file under their owners to pay the lower corporate income tax rate in order to free up more capital for small businesses; this would enable them to hire more workers and invest in equipment. These ideas form the basis of the pro-growth side of Trump’s proposal. The other side can be called the pro-family side and includes raising the standard deduction to $24,000 families, eliminating the alternative minimum tax, ending the estate tax, eliminating most itemized deductions, and reducing the current bracket levels from seven to three brackets of 10, 25, and 35%.

Vice President Pence acknowledges revenue losses could follow “maybe in the short term” but added that they would be overcome by economic growth. According to Gary Cohn, the President’s chief economic adviser, the result of these changes would be a 3% increase in the country’s measure of gross domestic product (GDP), a key measure of economic activity,  but the public has a right to worry about the proposal’s impact on the federal budget. Recent experience with tax cuts will weigh heavily on the minds of many Americans.

The inspiration for massive supply-side tax cuts comes from our experience with tax cuts in the eighties. President Reagan worked with conservatives in Congress, led by Representative Jack Kemp and Senator William Roth, to cut income tax rates by 23% over three years starting in 1982. Along with other changes to the tax code and maneuvers to combat inflation, conservatives often say that the loosening of capital helped trigger the “Reagan Recovery” beginning in 1983. While the federal government took an immediate hit of $17 billion, with years of sustained growing income, the loss of revenue was quickly recovered. However, because federal spending increased at the same time, the deficit increased by $24 billion. That still only represented 3% of GDP when Reagan left office, only 0.5% higher than his first year on the job.

It was that record that inspired the next big, bold tax cut of the modern era: the tax cuts of 2001 and 2003 commonly known as the Bush tax cuts. President Bush signed into law a temporary tax relief package that resulted in an immediate drop in revenue of $138 billion. Economic growth accelerated from 2001 to 2007 but not above the post-WWII average, and below the 3.3% rate of the 1990s. Within five years, federal revenue as a share of GDP fell from 18.8%, just above the historical average of 18.4%, to 14.6%. When the economy crashed in 2008, the impact on the federal budget was immense.

In 2009, President Obama took office in the midst of a dramatic economic slump and acted quickly to address it by increasing federal spending. It didn’t work. Growth barely accelerated back to average. The country experienced four years of trillion-dollar deficits from 2009 to 2012, and the failure to produce an immediate recovery helped Republicans retake control of the House of Representatives where they forced the president to pare back his spending requests in exchange for raising the debt ceiling. Through an indiscriminatory budget cut known as the sequester, spending dropped by a record $83 billion in 2012, and since some the Bush tax cuts also expired in 2013, the federal deficit was halved the next year. Revenue returned to its historical average and has hovered above 18% since.  

So how healthy is the American economy now? The day after the proposal was unveiled, Commerce announced that the first quarter of 2017 saw economic growth of only 0.7%. Economic growth has averaged 1.9% annually since 2000. It’s only right that President Trump and Congress would aim to address this slump and get the economy growing at 3%. Would these tax cuts spur that level of growth? If not, how serious is Washington when it comes to balancing the budget and avoiding higher interest rates that could wipe out any gains?

You can follow the author on Twitter @CACoreyU

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