With the release this week of an outline for changing the nation’s tax structure, President Trump has begun his promised task of cutting and reforming. On the surface, the White House seems to favor cutting over reforming, but these sketchy proposals are far from the last word—and a long way from law. Implemented in their current form, they would doubtless enlarge budget deficits, though not as much as the opposition will suggest. They would also accelerate economic growth, though probably not as profoundly as the White House suggests.
On the corporate side, Trump takes a bold initial position. He would slash the statutory rate on business income from 35 percent to 15 percent. Contrary to earlier promises, this reduction retains the many breaks and special credits in the current code, which will disappoint reformers, who have criticized these distortions as detriments to economic efficiency and growth. The breaks, the reformers note, retard investment by confusing decision-makers about the tax consequences of planned actions and, worse, prompt businesses to respond to the political preferences built into the code. Still, the reduction in the statutory rate makes these breaks less attractive.
Two new elements appeared in Trump’s outline. First is the move to eliminate the practice of taxing American corporations on their global income, instead taxing them only on their domestic earnings. Until now, Trump had talked merely about getting corporations to repatriate the accumulated earnings that they presently hold abroad—estimated recently at $2.4 trillion. Because this new reform would put the United States in line with global standards on corporate taxation, it would remove any incentive for multinational American firms to hold future earnings offshore.
A second new proposal would allow small businesses to “pass through” their earnings at the lower corporate tax rate of 15 percent instead of the higher individual rate. Though this change levels the playing field between large and small companies, it opens the door to abuse: people might set up dubious firms in order to secure the lower corporate rate. White House spokespeople have acknowledged the risk and issued assurances that the new law will disallow such scams, though they haven’t explained how.
Since these reductions have no offsets built into them, they will tend to enlarge Washington’s budget deficits. This effect shouldn’t be exaggerated, though. Last year, income from corporate taxes amounted only to slightly more than 10 percent of federal revenue. Even in the unlikely event that these cuts trimmed by one-third the flow of revenues from corporate sources, the overall deficit would still be lower than in 2013. Because the cuts will surely boost economic growth—and thus increase the flow of federal revenues—it’s likely that any deficit increases would remain manageable. It’s doubtful, though, that the growth acceleration would reach levels that would offset the cuts’ budgetary impact. A final determination will have to wait on events. Even estimates are hard to find right now: neither the White House nor any of Congress’s budget offices has run the numbers.
Trump, the self-described dealmaker, may have included some of the more contentious proposals, such as the low rate for pass-through earnings, as a bargaining chip for future negotiations. It’s too early to bet on any particular number or provision (or to consult legal counsel on how best to turn one’s children into an LLC). But the games in Washington have begun. They will move markets and make headlines regularly, until something gets signed into law—or doesn’t.
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