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Party of Growth

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Party of Growth

The Republicans’ new tax-reform law will increase productivity and wages. January 19, 2018
Economy, finance, and budgets
Politics and law

The Tax Cuts and Jobs Act, signed into law by President Trump just before Christmas, reshaped America’s tax code for the first time since 1986. The new law reduces marginal tax rates on individuals and businesses starting this year and pays for most—but not all—of those cuts by limiting special deductions and increasing growth. In doing so, the law encourages work and investment, while reducing costly distortions of economic activity.

The effects of the law will be multifaceted because the tax code is complex. Some will be good and some will be bad, but all nuance is lost on some critics. House Minority Leader Nancy Pelosi called the tax overhaul “the end of the world . . . this is Armageddon.” She later said it is “brazen theft” to allow taxpayers to keep more of their income. Former Treasury Secretary Larry Summers claims that the new law will cause thousands to die because its repeal of Obamacare’s individual mandate means that Americans will no longer be forced to purchase guaranteed-issue health insurance—even though, after the individual mandate took effect in 2014, the U.S. experienced consecutive years of falling life expectancy for the first time in over 50 years.

A more common criticism of tax reform is that it disproportionately benefits the wealthy. It’s a peculiar line of attack, though, because federal income taxes are already paid almost entirely by high-income people. In fact, the U.S. has the most progressive tax system in the developed world. The top 20 percent of earners make 53 percent of all income and pay 69 percent of federal taxes, according to the Congressional Budget Office. Meanwhile, the bottom 60 percent of earners earn 28 percent of income and pay 14 percent of taxes. Any across-the-board tax cut is unlikely to be extremely progressive in the narrow sense, because the system is already so much so.

Despite that, the new law should not significantly alter the progressivity of the tax code. In 2025, according to the left-leaning Tax Policy Center, 66 percent of the tax cuts will go to the top 20 percent, while 18 percent will go to the bottom 60 percent. The cuts are actually more progressive than the previous tax code. And this year, the average middle-income family will retain an extra $930 of their hard-earned money. It’s not easy to cut income taxes for people who pay little, but the law manages to do it.

Critics have also panned the reform for adding to the national debt. The congressional Joint Committee on Taxation estimates that the law will add $1 trillion to deficits through 2027, including growth effects. But cutting revenue by this magnitude—about 2 percent of total federal revenue over a decade—will not cause significant fiscal problems, because the primary source of expanding deficits will be accelerating entitlement spending, not less revenue. Paul Krugman of the New York Times has led a chorus of left-wing critics alleging that the tax cuts are merely a pretense for Paul Ryan to “cut”—or, more accurately, reduce the growth rate of—entitlements. They’re wrong. Total tax revenue will amount to 17.8 percent of GDP in the coming decade, higher than the historical average, and will continue to increase from there. Spending will rise from 21 percent of GDP in 2017 to 23 percent in 2027 to 26 percent in 2037, according to the CBO’s most conservative estimate. While criticism of the law’s debt effects is not entirely unwarranted, adjusting taxes up or down slightly does not change the unsustainable trajectory of our fiscal outlook. Spending is the problem, and the pretext for restraining it is reality.

Despite media focus on changes to the individual tax code, the most important reforms for growth are on the business side. Before the Tax Cuts and Jobs Act, the U.S. had the highest marginal corporate tax rate among developed nations—including France. Because it’s easier than ever for companies to shift capital and activity abroad, the previous corporate rate entailed major costs for the American economy.

The new law brings the top federal corporate rate down to 21 percent from 35 percent, slightly below the OECD average. It also shifts from a global toward a territorial tax system, like most other nations, which will give American firms more flexibility to repatriate capital. And for the first five years, the law permits companies immediately to write off the full cost of new capital investments. Because capital investment is the key driver of productivity and wages, the additional incentive to invest clearly improves prospects for American workers.

For all the analyses about the law’s effects, there is near consensus about its key consequence: it will grow the economy. The Joint Committee on Taxation projects that the new law will add 0.7 percent to output over ten years, the Penn Wharton Budget Model says it will increase GDP by 0.6 to 1.1 percent by 2027, and the independent Tax Foundation predicts that it will increase long-run output by 1.7 percent. Even left-leaning economists like Summers and former Obama advisor Jason Furman estimate that output will increase slightly, thanks to corporate tax changes.

A primary goal of America’s public policy should be to grow the economic pie, not redistribute the crumbs. This law adds to a litany of major policies where Republicans stand squarely in favor of growth and Democrats against. The Affordable Care Act shrinks the economy by 0.7 percent and reduces the workforce by the equivalent of 2 million full-time workers. The Dodd-Frank financial reform law’s onerous compliance requirements and restrictions on the loan business hurt community banks and small firms and decrease output by about 0.4 percent. President Obama’s administration published 494 “economically significant” regulations without congressional review that cost the economy at least $100 million each, while Trump’s is firmly committed to rationalizing America’s vast bureaucracy.

On issue after issue, Republicans are working to delimit the power of politicians and bureaucrats in favor of workers and businesses. With their latest reform, they have reduced the penalty to work and investment and removed an array of biases in the federal tax code. Consequently, Republicans have once again distinguished themselves as the party of growth and Democrats as the party of stagnation. As we head into an election year, voters should take note.

Photo: Xesai/iStock

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