Ramifications of the 2017 Trump tax plan

The proposed tax structure passes on efficiency and stabilisation but fails on equity consideration

The last fundamental US tax changes — mainly tax cuts — were undertaken three decades back during the Ronald Reagan administration, reflecting Arthur Laffer’s idea that lowering tax rates would fetch additional revenue. As it turned out, revenue loss was claimed to be 3 per cent of average gross domestic product (GDP) for 1981-85, the fiscal deficit increased, and the stock market fell. Post-facto, this led George H W Bush to call it “voodoo economics”.

Be history as it may, the Donald Trump White House has proposed a new tax plan by pointing to realities of the prevailing US tax scenario. Since 2001, there have been some 6,000 changes to the US tax code — currently four-million-word long — or more than one per day. At 35 per cent, the US has the highest corporate income tax (CIT) rate globally. There are 199 individual income tax (I-T) and 235 business tax return forms. Taxpayers spend some 7 billion hours and over $250 billion annually on compliance costs, with 90 per cent taxpayers needing help to complete returns.

The Trump tax plan’s (TTP) main components on the I-T side comprise: (1) Reduce the number of I-T brackets from seven to three of 10 per cent, 25 per cent and 35 per cent; (2) double the standard deduction; (3) provide tax relief for child and dependent care; (4) protect tax deductions for home ownership and charity; (5) repeal inheritance/death tax; and (6) repeal the 3.8 per cent Obamacare tax. On the business side: (1) Reduce CIT rate from 35 per cent to 15 per cent; (2) abolish alternate minimum tax (AMT); (3) eliminate tax incentives targeted to special interests; (4) introduce a one-time lower tax to facilitate the return of US funds held overseas; and (5) switch to a territorial CIT system to “level the playing field” for American companies. Mr Trump declared, “It will be bigger, I believe, than any tax cut ever. May be the biggest tax cut we’ve ever had!” Well, I-T cuts were more striking after the US Civil War. In 1870, it was brought down from a progressive 10 per cent to 2.5 per cent for all and, in 1872, abolished. (It was reinstated in 1894). The removal reflected a steep decline in the need for government resources after that war, starkly in contrast to US’ present resource needs. 

TTP needs to be tested against the three principles of taxation — efficiency, equity and stabilisation. Let us examine in that order. TTP scores well from an efficiency perspective. The abolition — or near abolition — of tax incentives would be a leap forward. It should minimise tax policy that stacks tax incentives into unrelated bills just to get the latter passed in the Congress, aptly termed, “pork barrelling”. Second, a drastic scaling back of the I-T and CIT rate structures may be anticipated to result in beneficial efficiency effects for decisions to invest, for labour supply, and for correcting price distortions across productive sectors. Similarly, the abolition of the inheritance/death tax should reduce unproductive inter-generational tax planning.  

According to calculations of the Urban-Brookings Tax Policy Center, revenue loss from the TTP over the next decade would be $7.68 trillion, probable revenue raisers $4.34 trillion, with a net loss of $3.34 trillion (see Table 2). These reductions would have negative equity effects. Though the US income tax structure is currently progressive, scaling back tax rates would reduce this progressivity, and take the US farther away from its European counterparts in the Organisation for Economic Co-operation and Development. Further, disproportionate benefits of a CIT rate reduction would be enjoyed by the highest income deciles where ownership of capital and capital’s returns lie disproportionately.

To analyse the stabilisation aspect, an exercise using Federal Reserve data was carried out. From available 2012-16 GDP figures, we calculated their annual growth rates (Table 1). We took their average and used it to project for 2017-27 annually. The cumulative GDP thus derived yielded a sum of $252.87 trillion (Table 2). We then divided the gross and net revenue loss from the TTP (calculated by the Institute) by this number to assess how the loss would be spread out over the next decade.

The figures thus obtained are surprising. On an average basis, the gross revenue loss from the tax cut would be 0.03 per cent of GDP per annum, and the net effect would be half of that. Consequently, calculations reveal that the fiscal deficit/GDP should increase by 1/3 of this. It may be cautiously concluded, therefore, that the TTP should not escalate a fiscal challenge and, if the supply side is responsive, it may beat the odds against lacklustre economic consequences over the forthcoming decade. However, recalling the unanticipated effects of the Reagan tax cuts, soothsaying on the TTP could be a dangerous exercise until its further details are spelt out by the White House. 

Obviously, the US has been historically able to afford taking risks regarding its fiscal deficit. Indeed, over 40 years, it enjoyed surpluses only during 1998-2001. It is common knowledge that the international seigniorage of the US dollar which remains the overwhelming vehicle currency in international trade settlements, affords it its fiscal deficit. However, Mr Trump cannot totally discount the consequences of an unanticipated rise in the fiscal deficit on inflation and, pari passu, a credit squeeze.

There has been some discussion over the form a “reformed” CIT should take. For example, to generate an effective halving of the CIT rate, one proposal was to remove export sales from taxable income to incentivise production. Any revenue loss could be compensated by a “corporate border adjustment consumption tax” on domestically consumed imports. Also termed a “destination-based cash flow tax”, it would strengthen the US dollar through an improved current account and keep consumer costs in check. This form of the CIT has, however, currently receded from the TTP. It may only be hoped that the final package will have characteristics that would not fall foul with the World Trade Organization, be palatable globally, and not lead to a trade war manifested in rising customs duties and non-tariff barriers from trading partners.

Sources: Economic Research Data, Federal Reserve Bank of St Louis

Notes:*Sum of projected GDP for 2017-27; **Source: Urban-Brookings Tax Policy Center, Washington, DC