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Republican Tax Plan Is No Revolution but It Will Boost the US Economy

Ryan Bourne

The legislative tax reform process in the United States is the
political equivalent of sausage making — a process so ugly it
risks turning you off the end product.

As a result, the package working its way through both houses of
Congress
now sits far from the lofty ideals of the fundamental
overhaul Republicans promised.

Nevertheless, it is reasonable to think that, on net, it will
improve US growth prospects. The plan, after all, substantially
lowers business taxation, cuts marginal tax rates on income and
eliminates a host of implicit subsidies within the tax code.

The key reform is that the US’s 35pc corporate tax rate
(currently the highest in the OECD) would be permanently cut to
20pc. As the economist Martin Feldstein has noted, this will
attract substantial capital to the US corporate sector, by
increasing the after-tax return on investment, encouraging profit
repatriation and more headquartering in the US, and shifting
capital from less productive sectors.

Higher investment, encouraged by this and the introduction of
full and immediate expensing for equipment investment for five
years, can be expected to boost productivity and wages. The
magnitudes here are hotly debated, but reasonable economic
estimates suggest this alone could raise GDP by between 1pc and 4pc
over 10 years.

Changes to the federal income tax have been less ambitious, but
could boost GDP further. The Republicans want lower marginal tax rates, paid
for by eliminating deductions that taxpayers are able to make.

The package of reforms would see a huge fall in the number of
households who seek to “itemise” — the wasteful
(from an economic perspective) filing of complex returns to
minimise their tax bills.

Though unlikely, there’s still even a chance the final
bill might restrict the mortgage interest deduction — widely
acknowledged by economists to lead to the over-consumption of
housing.

In order to make all this palatable, the GOP are doubling their
equivalent of the personal allowance and expanding credits for
families too. These will do little for growth, but tax reform is as
much about politics as economics.

Nevertheless, given the bills substantially cut a damaging tax,
trim marginal income tax rates and eliminate deductions —
long considered the holy grail of tax policy — why has the
Republican plan generated such fierce criticism?

From the Left, the plan is most commonly denounced as a sop to
the rich. Progressive economists highlight that the biggest cash
gainers are at the top of the income distribution. But this is in
part a statistical artefact, arising firstly because most on the
lowest incomes do not pay federal income taxes already and, second,
because procedural rules on future deficits mean that many
individual tax cuts are notionally scheduled to
“expire” in future years.

My colleague Chris Edwards calculates that in 2019,
when both corporate and individual tax cuts apply, all affected
income groups will see tax cuts on average
, with the biggest
coming for those earning between $40,000 (£30,000) and $50,000, who
see their tax bill halved on average. In comparison, those earning
over $1m would see their average tax bill fall by just 5.8pc.

A more legitimate economic concern is the effect on the US
public finances. The bill is forecast to add $1.5 trillion over 10
years to the national debt — lower once the macroeconomic
effects on growth are factored in; higher again if the tax cuts are
not allowed to expire.

This sum is unlikely to have catastrophic consequences for the
US’s ability to borrow, not least because it’s
relatively small compared to capital available on global markets.
But with the potential impact of a future recession and the
headwinds of an ageing population to come, there is a case for
getting the US’s fiscal house in order and this inevitably
will not help. Republicans have been right to highlight over many
years how, at a first approximation, the US’s terrifying debt
outlook is driven by rising entitlement spending caused by an
ageing population.

But they may find it that bit harder to make the case for
cutting future healthcare or pensions spending if they are seen to
be blasé about the debt in relation to tax cuts today.

Ryan Bourne
holds the R Evan Scharf Chair for the Public Understanding of
Economics at the Cato Institute.