The Republican tax plan retreads old, unflattering ground
For generations, the Republican Party has pitched the cure of tax cuts for whatever ails the American economy, and 2017 is no different. In an era of unprecedented disunity within the GOP, the only thing the White House and Congress can seem to agree on is taxes. As President Trump puts it, "Our country and our economy cannot take off like they should unless we dramatically reform America's outdated, complex, and extremely burdensome tax code."
What history says: If tax cuts are what the country needs to generate plentiful jobs and higher wages, it's reasonable to wonder why they didn't have that result when George W. Bush used the same approach in the early 2000s, or in several similar efforts going back to Ronald Reagan. Neither did the cuts arrest troubling trends like expanding income inequality, middling wage growth, and the rising costs of housing, education and health care.
Behind the theory: Advocates link tax cuts with economic growth, calling their approach "supply-side economics," whose most famous proponent is Arthur Laffer, a Reagan administration economist. They argue that higher tax rates convince valuable workers not to put in extra hours, and companies not to invest in new projects and equipment.
Looking back at prior tax cuts
The George W. Bush Tax Cuts: Bush's tax agenda initially focused on cutting personal income taxes, fulfilling a 2000 campaign promise to return money to taxpayers in response to an early but growing federal surplus begun under Bill Clinton. That changed in 2003, when a second round cut capital gains and dividend taxes, in what was described as an effort to stimulate the economy.
- History has not been kind to these cuts: The recovery following the 2001 recession was the slowest in history to that point in terms of recovering lost jobs.
- More aggressive investment did not follow: Reductions in capital gains and dividends taxes didn't translate into capital spending by businesses. Corporate investment in equipment that typically boosts worker pay didn't grow faster in the years following the tax cuts, plus pay for workers in the bottom 60% of the income distribution actually fell between 2002 and 2012.
- What tax cut advocates say today: Scott Greenberg, senior analyst with the Tax Foundation, asserts that the cuts were not about growing jobs and wages, but tax relief. To truly test the ability to turbocharge the economy, he tells Axios, Congress would have to enact much greater reduction in investment costs.
The Reagan tax cuts: Reagan's 1981 tax cut significantly increased the ability of businesses large and small to expense investments in capital and equipment. According to Greenberg, that made it the last true test of how American businesses large and small would respond to a consequential cut in taxes on their profits.
- Unlike the mid-2000s, job growth, business investment, and household income boomed during the Reagan years.
- Yes, but: Many consider the '81 cut to be a political and economic disaster. To get those kind of benefits, the government had to forgo a king's ransom, and the deficit swelled, forcing Reagan to pare back some of the changes to expensing.
- What tax cut advocates say today: Congressional Republicans want to do something similar this time around, allowing companies to fully expense capital investments. But the plan would cost as much as $2.2 trillion over ten years, which starts to look a lot like a rerun of the "yes, but" part of the Reagan cut.
Looking ahead to the current proposal
Voodoo economics? Because tax cuts big enough to make a splash cost so much money, proponents like to argue that their reforms will cause so much economic activity as to make the cut costless. This is Laffer's theory, explained in his famous "Laffer Curve," which posits that government revenue pours in after the elixir of a tax cut.
- The administration is promoting this theory now — but there's little evidence to support Laffer. Even the Tax Foundation, which has long advocated lower business taxes, says that when taking into account economic growth, a "full expensing" measure would cost closer to $1.5 trillion over ten years, while adding 800,000 new jobs and raising wages by 3.6% in the long run.
Deficit debate: Either way, $1.5 trillion or $2.2 trillion is a lot of money.
- But, maybe not enough to stop tax cut enthusiasts who don't want to fight over resources with advocates for universal health care and college tuition subsidies. The indications are that the Republicans will rerun the 2000s, and finance new tax cuts with deficit spending.
- To be sure: Republican deficit hawks, like retiring Sen. Bob Corker, are likely to balk at a plan that would balloon the deficit.
The bottom line: The Bush record make it difficult for conservatives to argue that large new income tax cuts for the top bracket will do much for the broader economy. The evidence from the 1980s presents a stronger case for slashing business taxes, but even so, the benefits of tax cuts are uncertain, while the costs are known, and significant.