The Republican Tax Plan: Government Debt Will Rise by More Than the $1.0 Trillion Commonly Cited

A.  Introduction

News reports are saying that the Senate Republican tax plan, rushed through and passed on a 51 to 49 vote late on a Friday night (actually, at 2 am on Saturday), will add an estimated $1.0 trillion to the national debt over the next ten years.  The number is based on figures provided in a staff report from the Joint Committee on Taxation (JCT) of Congress on the estimated tax revenue impacts.  But that is not what the JCT numbers say.  The actual increase in the federal debt will be almost a quarter more than that $1.0 trillion figure, even taking the JCT estimates as fine.  The problem is that they are being misinterpreted.

The JCT acts as a professional staff responsible for assessing the impacts of tax proposals before Congress (on behalf of both the Senate and the House), and must act in accord with instructions provided by the Congressional leadership.  They have traditionally worked out the revenue implications of the proposals sent to them (normally on a year by year basis over a ten-year horizon) as well as the distributional implications (what will be the effects by income group).  When Republicans took control of both the Senate and the House following the 2012 elections, JCT staff were also directed to provide what has been labeled “dynamic scoring”, which attempts to come up with an estimate of how economic growth may be affected and the revenue implications of that.  The assumption is that tax cuts will spur growth, and that with higher growth there will be an increase in tax revenues which would then (partially or possibly fully) offset what the revenue losses would otherwise be as a result of the tax cuts.

This is the old “supply-side economics”, which politicians starting with Reagan would cite as saying that tax cuts can pay for themselves.  The reality has been far different, as previous posts on this blog have argued.  The tax cuts of Reagan and Bush were followed by higher deficits, and slower (or at least not faster) growth than what followed after the tax increases approved under Clinton and Obama.  A fair reading of these experiences would not be that tax increases are good for growth and tax cuts bad for growth, but rather that the impacts, whatever they are, are too small to see in the data.

But the JCT staff are now required to provide some such estimate, and to do this they have to use economic models.  The constraints of such an approach will be discussed below.  But there is also a separate issue, which has unfortunately been confused with the impact of the growth estimates.  The issue is that the figures being provided by the JCT, on the year by year impact on tax revenues of the tax plan, are being confused with how far government debt will rise as a result of those tax losses.  Reporters are adding up the year by year tax revenue impacts over the ten year period of the forecasts, and concluding that that total will equal the resulting increase in government debt.  But that is not correct.  That simple addition of the year by year figures on tax losses leaves out the additional interest that will need to be paid on the debt incurred to cover those now higher fiscal deficits.  That additional interest will be significant.

B.  The Impact of Increased Interest on the Addition to the Federal Debt

The black curve in the chart at the top of this post, rising to $1,414 billion by FY2027, shows the simple accumulation of the lost tax revenues (year by year) following from the Senate Republican tax plan (November 16 version, as assessed by the JCT on November 17).  While the final plan passed by the Senate was a bit different (loopholes were being added or expanded up to the final hours, with also some offsetting tax increases), the net change in revenues in the final, approved, bill was relatively small, at $34 billion over the ten years (raising the cost to $1,448 billion from the $1,414 billion cost the JCT had estimated for the earlier version).  The JCT estimates of the macro impacts based on the $1,414 billion total will be close to what it would have been had they had the time to assess the final plan.

That path leading to the $1,414 billion cost total reflects the simple sum of the year by year tax revenue losses as a result of the Republican tax plan.  But those revenue losses will lead to larger deficits.  The larger deficits will mean additional federal debt, and interest will have to be paid on that additional debt.

Such additional interest needs to be paid year by year, and will accumulate over time.  The blue curve at the top, rising to $1,717 billion, is an estimate of what this would be, using the June 2017 interest rate forecasts (on government debt) from the Congressional Budget Office, and assuming, conservatively, interest paid in arrears with a one-year lag.  The total is $300 billion higher than the $1,414 billion figure.  That is, under this scenario federal government debt would increase by $1,717 billion over what it would otherwise have been by FY2027, not by the $1,414 billion figure.  News reports commonly got this wrong.  It is not that the JCT got it wrong.  Rather, news reports misinterpreted what the JCT figures were saying.

The question then is whether there will be macro economy impacts, as the supply-siders assert, and if so, how large they would be.  The JCT provided on November 30, estimates of what these might be.  Based on a weighted average of results from three different economic models of the economy, the JCT estimated that at the end of the ten year period (i.e. in 2027), GDP would be 0.8% higher than it would be otherwise.  That is, the growth rate would on average be 0.08% per year higher than otherwise.  This is not much but still is something.  The resulting higher GDP would raise tax revenues above what they would otherwise be following the tax cuts.  Tax revenues would still decline – they just would not decline by as much as before.  Federal debt would still rise.  The higher deficits over the ten years would sum to $1,007 billion by 2027 (the green curve in the chart above).  And once again, news reports concluded that the new JCT figures were saying that federal debt would rise by $1.0 trillion over the ten year period once those macro impacts were taken into account.

But the JCT figures are not saying that.  They simply show the year by year impacts.  And as before, the JCT figures do not include the impact of the increase in interest that will need to be paid on a federal debt that would be higher than otherwise due to the tax cuts.  Adding in these interest payments, on a growing debt resulting from the yearly reduction in tax revenues in this tax plan, leads to the red curve in the chart.  The JCT figures imply, once one adds in the now higher interest payments due, a federal debt that by 2027 would be $1,245 billion higher than what it would otherwise be.  This is roughly a quarter higher, or an extra $240 billion, over the figure the news reports are citing.  This is not a small difference.

C.  Other Points

There are a few other points worth noting:

a)  One can see in the chart at the top of this post how the additions to the federal debt level off in 2026, and in most cases then decline.  This is because most of the provisions that would cut individual income taxes are ended as of the end of CY2025 under the Republican proposal.  The losses in tax revenues from the tax plan would then continue to grow through FY2026 (due to the overlap between CY2025 and FY2026, and the fact that final taxes due for CY2025 will be paid in April 2026) leading to still growing debt in 2026, but then level off or fall after that.  By FY2027, the JCT assessment found that most individuals would end up with higher taxes due.  Indeed, the Senate Republican tax plan is structured so that individuals in FY2027 would on average end up paying more in taxes than they would if this tax plan were never to go into effect.  In contrast to the sunsetting of the individual income tax cuts, the corporate income tax cuts would be made permanent.  And if, as the Republicans say they actually want, the individual income tax cuts are also made permanent, then the federal debt will grow by even more than what would result under the current plan.  They cannot have it both ways.

b)  Furthermore, while the focus here is on the impacts on total revenues collected and hence on the federal debt, there will also be critical distributional implications.  The JCT assessment of the November 16 version of the Republican tax plan found that if one adds together the impacts on households of all the proposals (on both the individual and the business side), that in 2027, those families with incomes of less than $75,000 would be paying more in taxes than they would if this tax plan were never approved (taking averages for each income group, as individual experiences will vary).  However, those with incomes of $75,000 or more would all be enjoying tax cuts.  The figures on a per family basis (technically per taxpayer unit) are shown in my earlier blog post on the Republican plan.  But it is not just in 2027 that certain income groups will be paying more in taxes.  Adding up the net impacts by income group over the full ten years, one finds that those with incomes of up to $30,000 will be paying more in taxes in total over the full ten years (of about $900 per family on average).  These are the families who are least able to afford a tax hike.

c)  It is important to clarify one statement in the JCT report on the macro impacts.  It makes reference to a $50 billion figure for “an increase in interest payments on the Federal debt”.  This is stated in the opening paragraph, and then in a bit more detail on page 6 in the section labeled “Budgetary effects”.  This increase in interest due is netted out in the figure summing to the $1,007 billion for the total cost over ten years of the Republican plan.

At first I had thought this interest cost reflected what I am discussing here – the increase in interest payments that will be due over the period as a result of the greater borrowing following from the higher deficits.  However, the $50 billion number is far too small, as the higher amount due in interest from the higher debt would be more like $240 billion.  I at first thought there might have been a mistake in the JCT calculations.  But a close reading of the JCT report shows that the $50 billion figure is actually referring to something else.  That something else is that one should expect general interest rates to rise in the economy as a result of the higher fiscal deficits, and that this will then lead to higher interest due on the existing federal government debt.  The increase in interest rates might be relatively small, but with the large government debt, even a small increase in interest rates can matter.  And one can calculate that a $50 billion increase in interest due would result from a rise in average interest rates on government debt of 0.025%, i.e. from the 3.7% that the CBO forecasts for most of this period, to 3.725%.

One must therefore not confuse the $50 billion in increased interest payments due on the existing federal debt (which the JCT estimates), with the increase in interest that will be due as a result of the year by year higher federal deficits, which must then be funded by borrowing.  The JCT, following the instructions given to it by the Congressional leadership, is not estimating the latter.  But the latter does add to the federal debt, and hence the addition to the federal debt by 2027 as a consequence of this Republican tax plan would be more like $1,245 billion than the $1,007 billion that the news media is mistakenly saying.

d)  As noted above, the JCT arrives at a forecast, based on the models it is using, that GDP would be 0.8% higher in 2027 than it would otherwise be.  The increase is small (increased growth of just 0.08% a year), but something.  News reports have made much of it.  But not noted (from what I have seen) is any discussion in the news reports of what the JCT estimated would happen after that.

The JCT discusses this on page 6 of its report.  It notes that due to the reversal of most of the individual income tax cuts (while leaving in place measures that would lead to higher individual income taxes), coupled with the rising interest rates resulting from the higher deficits (the $50 billion figure discussed above, but growing over time), the impact on GDP by the end of the third decade of such measures would be partially or wholly offset.  The growth effects die out over time.  As a result, we will then be left with a higher federal debt, but GDP the same or similar, and hence a government debt burden that is then higher for our grandchildren than would be the case if this tax plan were never approved.

e)  And it is critically important to recognize that the JCT could only arrive at its estimates of what the impact would be on GDP via economic models.  They did recognize that any individual economic model has issues, and therefore they used three different ones.  The 0.8% increase in GDP forecast for 2027 was the weighted average outcome of those three, weighting them not equally, but rather by 40/40/20.  Each model approaches the issue differently.  And while the JCT report is honest on what they did, and did report on the numbers used for some of the key parameters in each of the models, one would have liked to see more.

To start, only the 0.8% figure was given, resulting from the weighted average of the individual model forecasts.  One would have liked to have seen what the individual model results were.  Were they all fairly close to the 0.8% figure (in which case one would take some comfort in the similar findings), or did the different models produce quite different forecasts?  If the latter, one can not place much confidence in the overall weighted average as providing a robust estimate.

But more fundamentally, one needs to recognize that these are forecasts produced by models.  The results the models will produce will depend on the model structure assumed (as set by the analyst), and on the specific values assumed for the key model parameters.  The fact that the JCT used three different models for this (and reasonably so) shows how unsettled such analysis is.  Different models can come up with completely different results, as different aspects of the economy will be emphasized by each modeler.

The fundamental problem is that it is difficult to impossible to be able to say from actual data observed what the best model might be.  The overall net effects on growth are just too small, and there is so much going on also with the economy that one cannot come up with robust estimates of the impacts of such changes in tax law.  It is important to recognize that changes in tax law can have expansionary effects in some areas (including not just in different sectors but also in different areas of economic behavior) and contractionary effects in others.  The overall impact will depend on the net impact of them all, and this can be small to non-existent as the individual effects can go in opposite directions.  Hence one does not see in the observed data on GDP any indication that such changes in tax law (as have occurred in the past) have led to higher (or lower) GDP.

This was discussed in a previous post on this blog with regard to the impact on labor supply (and hence output) from a change in individual income tax rates.  There are income effects as well as substitution effects, their impacts go in opposite directions, and the net impact may then be small or not there at all as they simply offset each other.  There is a similar problem with assessing the impact on investment from changes in the corporate income tax proposals.  While some would argue that a lower corporate income tax rate will spur investment, the proposal also to limit the deductibility of interest on borrowed funds will act to reduce the incentive to invest.  The weighted average cost of capital (after taxes) will be higher when interest is not deductible, and the decision to invest depends on the balance between the (after-tax) expected return on investment and the (after tax) weighted average cost of capital for the funds being invested.

The net impact on the economy is therefore an empirical question, and one cannot say from ex-ante theorizing alone what that net impact might be.  One can construct models based on different theories, but then the net impact will depend on the model structures assumed and the specific values chosen for the various parameters used.  These can be difficult to impossible to estimate independently.

Finally, any such models will only be able to focus on a few of the possible changes in tax law.  They will not have the granularity to assess properly the literally hundreds of changes in law that the Republican tax plan includes.  Depending on the success or not of different interest groups and their lobbyists, the Republican tax plan has special favors, or harms, for different groups, and no economic model can capture all of them.  The models used by the JCT are, of necessity, much broader.

D.  Conclusion

To conclude, the JCT report on the macro impacts from the Republican tax plan is important and valuable, but is typically being misinterpreted.  The increase in the federal debt resulting from the tax cuts will be significantly higher than what one obtains by a simple summation of the year by year revenue impacts, as those impacts do not take into account the interest that will need to be paid on the now higher federal debt.  Those additional interest payments will be significant, and the addition to the federal debt will be about a quarter higher by the end of ten years than what a simple sum of the year by year losses in tax revenue would come to.

The JCT also concluded that its best estimate of the impact on GDP of the tax plan after ten years was that GDP would be 0.8% higher.  This is not much – an increase in the growth rate of just 0.08% a year.  Furthermore, even this would die out by the end of the third decade, in the tax plan as proposed.  The nation would then end up with a higher debt, a GDP which is about the same, and hence a debt to GDP ratio which is higher.

But of necessity, the estimates of the impact on GDP from the tax plan are crude.  The JCT was required to come up with such an estimate, but the only way to do this is to assume some economic model applies.  There is no good basis for choosing one, so the JCT used three, and the 0.8% figure is a weighted average of what those three different models forecast.  It would have been nice to see what each of those three forecasts were, to see if they were broadly similar.

All one can reasonably conclude is that the net impact on GDP is likely to be small.  This is consistent with what we have seen historically.  Any impacts on GDP, positive or negative, from such tax law changes have been too small to see in the data.  And there is certainly no reason to believe that such changes in tax law will lead to such a strong response in growth that the tax cuts “will pay for themselves”.  This has never happened before, and the JCT results indicate it will not happen now.

The Revenue and Distributional Impacts of the Senate Republican Tax Plan

A.  Introduction

To truly understand the Republican tax plans now winding their way through Congress, one must look at the specifics of what is being proposed.  And the more closely one looks, the more appalling these plans are seen to be.  The blatant greed is breathtaking.  Despite repeatedly asserting that the plans would provide tax cuts for the middle class, the specific proposals now before Congress would in fact do the opposite.  Figures will be provided below.  And while the Secretary of the Treasury has repeatedly stated that only millionaires will pay more in taxes, the specific proposals now before Congress would in fact give millionaires huge cuts in the taxes they owe.

While provisions in the plans are changing daily, with certain differences between the versions being considered in the House and in the Senate as well as between these and what the White House set out in late September, the overall framework has remained the same (as the proponents themselves are emphasizing).  And this really is a Republican plan.  The House version was passed on a largely party-line vote with no Democrats in favor and only a small number of Republicans opposed, and the Senate version will require (assuming all Democrats vote against as they have been shut out of the process) 50 of the 52 Republican Senators (96%) to vote in favor.  The Republican leadership could have chosen to work with Democrats to develop a proposal that could receive at least some Democratic support, but decided not to.  Indeed, while their plans have been developed by a small group since Trump assumed the presidency in January, the specifics were kept secret as long as possible.  This made it impossible (deliberately) for there to be any independent analysis.  They are now trying to rush this through the House and the Senate, with votes taken as quickly as possible before the public (and the legislators themselves) can assess what is being voted upon.  The committees responsible for the legislation have not even held any hearings with independent experts.  And the Congressional Budget Office has said it will be unable to produce the analysis of the impacts normally required for such legislation, due to the compression of the schedule.

Fortunately, the staff of the Joint Committee on Taxation (JCT, a joint committee of both the House and the Senate) have been able to provide limited assessments of the legislation, focused on the budgetary and distributional impacts, as they are minimally required to do.  This blog post will use their most recent analysis (as I write this) of the current version of the Senate bill to look at who would be gaining and who would be losing, if this plan is approved.

As a first step, however, it would be good to address the claim that these Republican tax plans will spur such a jump in economic growth that they will pay for themselves.  This will not happen.  First, as earlier posts on this blog have discussed, there is no evidence from the historical data to support this.  Taxes, both on individuals and at the corporate level, have been cut sharply in the US since Reagan was president, and they have not led to higher growth.   All they did was add to the deficit.  Nor does one see this in the long-term data.  The highest individual income tax rates were at 91 or 92% (at just the federal level) between 1951 and 1963, and at 70% or more up until 1980.  The highest corporate income tax rate was 52% between 1952 and 1963, and then 46% or more up until 1986.  Yet the economy performed better in these decades than it has since.  The White House is also claiming that the proposed cut in corporate income taxes will lead to a rise in real wages of $4,000 to $9,000.  But there is no evidence in the historical data to support such a claim, which many economists have rejected as just absurd.  Corporate income tax rates were cut sharply in 1986, under Reagan, but real wages did not then rise – they in fact fell.

Finally, the assertion that tax cuts will lead to a large jump in growth ignores that the economy is already at full employment.  Were there to be an incipient rise in growth, leading to employment gains, the Federal Reserve Board would have to raise interest rates to keep the economy from over-heating.  The higher interest rates would deter investment, and one would instead have a shift in shares of GDP away from investment and towards consumption and/or government spending.

Any impact on growth would thus be modest at best.  The Tax Policy Center, using generous assumptions, estimated the tax plan might increase GDP by a total of 0.3% in 2027 and by 0.2% in 2037 over what it would otherwise then be.  An increase of 0.2% over 20 years means an increase in the rate of growth of an average of just 0.01% a year.  GDP figures are not even measured to that precision.

There would, however, be large distributional effects, with some groups gaining and some losing simply from the tax changes alone (and ignoring, for the purposes here, the further effects from a higher government debt plus increased pressures to cut back on government programs).  This blog post will discuss these, from calculations that draw on the JCT estimates of the revenue and distributional impacts.

B.  Revenue Impacts by Separate Tax Programs

The distributional consequences of the proposed changes in tax law depend on which separate taxes are to be cut or increased, what changes are made to arrive at what is considered “taxable income” (deductions, exemptions, etc.), and how those various taxes impact different individuals differently.  Thus one should first look at the changes proposed for the various taxes, and what impacts they will have on revenues collected.

The JCT provides such estimates, at a rather detailed level as well as year by year to FY2027.  The JCT estimates for the tax plan being considered in the Senate as of November 16 is available here.  Estimates are provided of the impacts of over 144 individual changes, for both income taxes on individuals and on various types of business (corporate and other).  A verbal description from the JCT of the Senate chair’s initial proposal is available here, and a description of the most recent changes in the proposal (as of November 14) is available here.  I would encourage everyone to look at the JCT estimates to get a sense of what is being proposed.  It is far more than what one commonly sees in the press, with many changes (individually often small in terms of revenue impact) that can only be viewed as catering to various special interests.

I then aggregated the JCT individual line estimates of the revenue impacts over FY18-27 to a limited set of broad categories to arrive at the figures shown in the chart at the top of this post, and (in a bit more detail) in the following table,:

Revenue Impact of Tax Plan ($billions)

FY18-27

A)  Individual excl. Estate, AMT, & Pass-Through:

  1)  Cuts

-$2,497

  2)  Increases 

 $2,688

     Net, excl. Estate, AMT, & Pass-Through  

    $191

B)  Primarily Applicable to the Rich:

  1)  Increase Estate Tax Exemption

     -$83

  2)  End Alternative Minimum Tax

   -$769

  3)  Tax Pass-Through Income at Lower Rates

   -$225

     Total for Provisions Primarily for Rich

-$1,077

C)  Business – Domestic Income:

  1)  Cut Tax Rate 35% to 20%, and End AMT 

-$1,370

  2)  Other Tax Cuts

   -$139

  3)  Tax Increases

    $826

     Net for Domestic Business

   -$682

D)  Business – Overseas Income:

  1)  End Taxation of Overseas Profit

  -$314

  2)  Other Tax Cuts

    -$21

  3)  Tax Increases (except below)

     $32

     Net for Overseas, excl. amnesty & anti-abuse 

  -$303

  4)  Partial Amnesty on Overseas Profit

    $185

  5)  Anti-abuse, incl. in Tax Havens

    $273

     Overall Totals

-$1,414

Source:  Calculated from estimated tax revenue effects made by the staff of the Joint Committee on Taxation, publication JCX-59-17, November 17, 2017, of the November 16 version of the Republican Chairman’s proposed tax legislation.

a)  Individual Income Taxes

As the chart and table show, while overall tax revenues would fall by an estimated $1.4 trillion over FY18-27 (excluding interest on the resulting higher public debt), not everyone would be getting a cut.  Proposed changes that would primarily benefit rich individuals (doubling the Estate Tax exemption amount to $22 million for a married couple, repealing the Alternative Minimum Tax in full, and taxing pass-through business income at lower rates than other income) would reduce the taxes the rich owe under these provisions by close to $1.1 trillion.  But individual income taxes excluding these three categories would in fact increase, by an estimated $191 billion over the ten years.

This increase of $191 billion in income taxes that most affect the middle and lower income classes, is not a consequence of an explicit proposal to raise their taxes.  That would be too embarrassing.  Rather, it is the net result of numerous individual measures, some of which would reduce tax liability (and which the politicians then emphasize) while others would increase tax liabilities (and are less discussed).  Cuts totaling $2.5 trillion would come primarily from reducing tax rates, from what they refer to as a “doubling” of the standard deduction (in fact it would be an increase of 89% over the 2017 level), and from increased child credits.  But there would also be increases totaling close to $2.7 trillion, primarily from eliminating the personal exemption, from the repeal of or limitation on a number of deductions one can itemize, and from changes that would effectively reduce enrollment in the health insurance market.

Part of the reason for this net tax increase over the full ten years is the decision to try to hide the full cost of the tax plan by making most of the individual income tax provisions (although not the key changes proposed for corporate taxes) formally temporary.  Most would expire at the end of 2025.  The Republican leadership advocating this say that they expect Congress later to make these permanent.  But if so, then the true cost of the plan would be well more than the $1.5 trillion ceiling they have set under the long-term budget plan they pushed through Congress in September.  Furthermore, it makes only a small difference if one calculates the impact over the first five years of the plan (FY18-22).  There would then be a small net reduction in these individual income taxes (excluding Estate Tax, AMT, and Pass-Through) of just $57 billion.  This is not large over a five year period – just 0.6% of individual income taxes expected to be generated over that period.  Over this same period, the cuts in the Estate Tax, the AMT, and for Pass-Through income would total $535 billion, or well over nine times as much.

One should also keep in mind that these figures are for overall amounts collected, and that the impact on individuals will vary widely.  This is especially so when the net effect (an increase of close to $200 billion in the individual income taxes generated) is equal to the relatively small difference between the tax increases ($2.7 trillion in total) and tax cuts ($2.5 trillion).  Depending on their individual circumstances, many individuals will be paying far more, and others far less.  For example, much stress has been put on the “doubling” of the standard deduction.  However, personal exemptions would also be eliminated, and in a household of just three, the loss of the personal exemptions ($4,050 per person in 2017) would more than offset the increase in the standard deduction (from $12,700 to a new level of $24,000).  The change in what is allowed for the separate child credits will also matter, but many households will not qualify for the special child credits.  And if one is in a household which itemizes their deductions, both before and after the changes and for whatever reason (such as for high medical expenses), the “doubling” of the standard deduction is not even relevant, while the elimination of the personal exemptions is.

Taxes relevant to the rich would be slashed, however.  Only estates valued at almost $22 million or more in 2017 (for a married couple after some standard legal measures have been taken, and half that for a single person) are currently subject to the Estate Tax, and these account for less than 0.2% of all estates.  The poorer 99.8% do not need to worry about this tax.  But the Senate Republican plan would narrow the estates subject to tax even further, by doubling the exemption amount.  The Alternative Minimum Tax (AMT) is also a tax that only applies to relatively well-off households.  It would be eliminated altogether.

And pass-through income going to individuals is currently taxed at the same rates as ordinary income (such as on wages), at a rate of up to 39.6%.  The current proposal (as of November 16) is to provide a special deduction for such income equal to 17.4%.  This would in effect reduce the tax rate applicable to such income from, for example, 35% if it were regular income such as wages (the bracket when earnings are between $400,000 and $1.0 million in the current version of the plan) to just 28.9%.  Pass-through income is income distributed from sole proprietorships, partnerships, and certain corporations (known as sub-chapter S corporations, by the section in the tax code).  Entities may choose to organize themselves in this way in order to avoid corporate income tax.  Those receiving such income are generally rich:  It is estimated that 70% of such pass-through income in the US goes to the top 1% of earners.  Such individuals may include, for example, the partners in many financial investment firms, lawyers and accountants, other professionals, as well as real estate entities. There are many revealing examples.  According to a letter from Trump’s own tax lawyers, Trump receives most of his income from more than 500 such entities.  And Jeff Bezos, now the richest person in the world, owns the Washington Post through such an entity (although here the question might be whether there is any income to be passed through).

The JCT estimates are that $83 billion in revenue would be lost if the Estate Tax exemption is doubled, $769 billion would be lost due to a repeal of the AMT, and $225 billion would be lost as a result of the special 17.4% deduction for pass-through income.  This sums to $1,077 billion over the ten years.

Rich individuals thus will benefit greatly from the proposed changes.  Taxes relevant just to them will be cut sharply.  These taxes are of no relevance to the vast majority of Americans.  With the proposal as it now stands, most Americans would instead end up paying more over the ten year period.  And even if all the provisions with expiration dates (mostly in 2025) were instead extended for the full period, the difference would be small, with at best a minor cut on average.  It would not come close to approaching the huge cuts the rich would enjoy.

b)  Taxes on Income of Corporations and Other Businesses

The proposed changes in taxes on business incomes are more numerous.  They would also in general be made permanent (with some exceptions), rather than expire early as would be the case for most of the individual income tax provisions.  There are also numerous special provisions, with no obvious explanation, which appear to be there purely to benefit certain special interests.

To start, the net impact on domestic business activities would be a cut of an estimated $682 billion over the ten year period.  The lower tax revenues result from cutting the tax rate on corporate profits from 35% to 20%, plus from the repeal of the corporate AMT.  The cuts would total $1,370 billion.  This would be partially offset by reducing or eliminating various deductions and other measures companies can take to reduce their taxable income (generating an estimated $826 billion over the period).

However, there would also be measures that would cut business taxes even further (by an estimated $139 billion) on top of the impact from the lower tax rates (and elimination of the AMT).  Most, although not all, of these would be a consequence of allowing full expensing, or accelerated depreciation in some cases, of investments being made (with such full expensing expiring, in most cases, in 2022).  The objective would be to promote investment further.  This is reasonable, but with full expensing of investments many question whether anything further is gained, in terms of investment expenses, from cutting the corporate rate to 20%.

Special provisions include measures for the craft beer industry, which would reduce tax revenues by $4.2 billion.  The rationale behind this is not fully clear, and it would expire in just two years, at the end of 2019.  The measures should be made permanent if they are in fact warranted, but their early expiration suggests that they are not.  Also odd is a provision to allow the film, TV, and theater industries to fully expense certain of their expenses.  But this provision would expire in 2022.  If warranted, it should be permanent.  If not, it should probably not be there at all.

There are a large number of such special provisions.  Individually, their tax impact is small.  Even together the impact is not large compared to the other measures being proposed.  They mostly look like gifts to well-connected interests.

Others lose out.  These include provisions that allow companies to include as a cost certain employee benefits, such as for transportation, for certain employee meals (probably those provided in remote locations), and for some retirement savings provisions.  Workers would likely lose from this.  The proposal would also introduce new taxes on universities and other non-profits, including taxes on certain endowment income and on salaries of certain senior university officials (beyond what they already pay individually).  The revenues raised would be tiny, and this looks more like a punitive measure aimed at universities than something justified as a “reform”.

There would also be major changes in the taxes due on corporate profits earned abroad.  Most importantly, US taxes would no longer be due on such activities.  While this would cost in taxes a not small $314 billion (or $303 billion after a number of more minor cuts and increases are accounted for) over the ten years, also significant is the incentive this would create to relocate plants and other corporate activities to some foreign location where local taxes are low.  There would be a strong incentive, for example, to relocate a plant to Mexico, say, if Mexico offered only a low tax on profits generated by that plant.  The same plant in the US would pay corporate income taxes at the (proposed) 20% rate.  How this incentive to relocate plant abroad could possibly be seen as a positive by politicians who say they favor domestic jobs is beyond me.  It appears to be purely a response to special interests.

The corporate tax cuts are then in part offset by a proposal to provide a partial amnesty on the accumulated profits now held overseas by US companies.  Certain assets held overseas as retained earnings would be taxed at 5% and certain others at 10%.  Under current US law, corporate profits earned overseas are only subject to US taxes (at the 35% rate currently, net of taxes already paid abroad in the countries where they operate) when those profits are repatriated to the US.  As long as they are held overseas, they are not taxed by the US.  An earlier partial amnesty on such profits, in 2004 during the Bush administration, led to the not unreasonable expectation that there would again be a partial amnesty on such taxes otherwise due when Republicans once again controlled congress and the presidency.  This created a strong incentive to hold accumulated retained earnings overseas for as long as possible, and that is exactly what happened.  Profits repatriated following the 2004 law were taxed at a rate of just 5.25%.

The result is that US companies now hold abroad at least $2.6 trillion in earnings.  And this $2.6 trillion estimate, commonly cited, is certainly an underestimate.  It was calculated based on a review of the corporate financial disclosures of 322 of the Fortune 500 companies, for the 322 such companies where disclosures permitted an estimate to be made.  Based also on the deductible foreign taxes that had been paid on such overseas retained earnings, the authors conservatively estimate that $767 billion in corporate income taxes would be due on the retained earnings held overseas by the 322 companies.  But clearly it would be far higher, as the 322 companies, while among the larger US companies, are only a sub-set of all US companies with earnings held abroad.

Thus to count the $185 billion (line D.4. in the table above) as a revenue-raising measure is a bit misleading.  It is true that compared to doing nothing, where one would leave in place current US tax law which allows taxes on overseas profits to be avoided until repatriated, revenues would be raised under the partial amnesty if those accumulated overseas earnings are now taxed at 5 or 10%.  But the partial amnesty also means that one will give up forever the taxes that would otherwise be due on the more than $2.6 trillion in earnings held overseas.  Relative to that scenario, the amnesty would lead to a $582 billion loss in revenues (equal to an estimated $767 billion loss minus a gain of $185 billion from the 5 and 10% special rates of the amnesty; in fact the losses would be far greater as the $767 billion figure is just for the 322 companies which publish data on what they are holding abroad).  This is, of course, a hypothetical, as it would require a change in law from what it is now.  But it does give a sense of what is being potentially lost in revenues by providing such a partial amnesty.

But even aside from this, one must also recognize that the estimated $185 billion gain in revenues over the next few years would be a one time gain.  Once the amnesty is given, one has agreed to forego the tax revenues that would otherwise be due.  It would help in reducing the cost of this tax plan over the next several years, but it would then lead to losses in taxes later.

Finally, as is common among such tax plans, there is a promise to crack down on abuses, including in this case the use of tax havens to avoid corporate taxes.  The estimate is that such actions and changes in law would raise $273 billion over the next ten years.  But based on past experience, one must look at such estimates skeptically.  The actual amounts raised have normally been far less.  And one should expect that in particular now, given the underfunding of the IRS enforcement budget of recent years.

C.  Distributional Impacts

The above examined what is being proposed for separate portions of the US tax system.  These then translate into impacts on individuals by income level depending on how important those separate portions of the tax system are to those in each income group.  While such estimates are based on highly detailed data drawn from millions of tax returns, there is still a good deal of modeling work that needs to be done, for example, to translate impacts on corporate taxes into what this means for individuals who receive income (dividends and capital gains) from their corporate ownership.

The Tax Policy Center, an independent non-profit, provides such estimates, and their estimate of the impacts of the Republican tax plans (in this case the November 3 House version) has been discussed previously on this blog.  The JCT also provides such estimates, using a fundamentally similar model in structure (but different in the particulars).

Based on the November 15 version of the Senate Republican plan, the JCT estimated that the impacts on households (taxpayer units) would be as follows:

Overall Change in Taxes Due per Taxpayer Unit

Income Category

2019

2021

2023

2025

2027

Less than $10,000

-$21

-$5

$9

$11

$18

$10 to $20,000

-$49

$136

$180

$180

$307

$20 to $30,000

-$87

$138

$144

$170

$355

$30 to $40,000

-$288

-$97

-$16

-$10

$284

$40 to $50,000

-$496

-$275

-$197

-$187

$283

$50 to $75,000

-$818

-$713

-$607

-$610

$139

$75 to 100,000

-$1,204

-$1,150

-$962

-$994

-$38

$100 to $200,000

-$2,091

-$2,027

-$1,622

-$1,657

-$118

$200 to $500,000

-$6,488

-$6,319

-$5,176

-$5,510

-$462

$500 to $1,000,000

-$21,581

-$20,241

-$15,611

-$16,417

-$1,495

Over $1,000,000

-$58,864

-$48,175

-$21,448

-$25,111

-$8,871

Total – All Taxpayers

-$1,357

-$1,200

-$901

-$950

$57

Source:  Calculated from estimates of tax revenue distribution effects made by the staff of the Joint Committee on Taxation, publication JCX-58-17, November 16, 2017, of the November 15 version of the Republican Chairman’s proposed tax legislation.

By these estimates, each income group would, on average, enjoy at least some cut in taxes in 2019.  A number of the proposed tax measures are front-loaded, and it is likely that this structure is seen as beneficial by those seeking re-election in 2020.  But the cuts in 2019 vary from tiny ($21 for those earning $10,000 or less, and $49 for those earning $10,000 to $20,000), to huge ($21,581 for those earning $500,000 to $1,000,000, and $58,864 for those earning over $1,000,000).  However, from 2021 onwards, taxes due would actually rise for most of those earning $40,000 or less (or be cut by minor amounts).  And this is already true well before the assumed termination of many of the individual income tax measures in 2025.  With the plan as it now stands, in 2027 all those earning less than $75,000 would end up paying more in taxes (on average) under this supposed “middle-class tax cut” than they would if the law were left unchanged.

The benefits to those earning over $500,000 would, however, remain large, although also declining over time.

D.  Conclusion

The tax plan now going through Congress would provide very large cuts for the rich.  One can see this in the specific tax measures being proposed (with huge cuts in the portions of the tax system of most importance to the rich) and also in the direct estimates of the impacts by income group.  There are in addition numerous measures in the tax plan of interest to narrow groups, that are difficult to rationalize other than that they reflect what politically influential groups want.

The program, if adopted, would lead to a significantly less progressive tax system, and to a more complex one.  There would be a new category of income (pass-through income) receiving a special low tax rate, and hence new incentives for those who are well off to re-organize their compensation system when they can so that the incomes they receive would count as pass-through incomes.  While the law might try to set limits on these, past experience suggests that clever lawyers will soon find ways around such limits.

There are also results one would think most politicians would not advocate, such as the incentive to relocate corporate factories and activities to overseas.  They clearly do not understand the implications of what they have been and will be voting on.  This is not surprising, given the decision to try to rush this through before a full analysis and debate will be possible.  There have even been no hearings with independent experts at any of the committees.  And there is the blatant misrepresentation, such as that this is a “middle-class tax cut”, and that “taxes on millionaires will not be cut”.

If this is passed by Congress, in this way, there will hopefully be political consequences for those who chose nonetheless to vote for it.

The Republican Tax Cut Plan Really is Biased Towards the Rich

The respected Tax Policy Center (TPC), a non-partisan think tank set up as a joint venture of Brookings and the Urban Institute, released on November 8 its first estimates of the distributional impact of the November 3 Republican tax proposal.  The TPC runs a sophisticated micro-simulation model of the US tax system, using a large but anonymous set of tax returns to determine the impact of proposed changes in tax law.  The model is similar in nature to models run by the US Treasury and in Congress, but with full disclosure of the results and how they arrived at the estimates that they obtained.

As was discussed in an earlier post on this blog (on the Trump plan released in late September), these Republican plans will provide huge cuts in taxes for the very rich, and far more modest cuts for others.  The November 3 plan released by the Republican Chair of the House Ways and Means Committee (the committee responsible for all tax issues) is the first fully detailed plan for which good quantitative estimates can now be made of the impact by income group.  While certain elements in the proposal are changing daily, with the Republican leadership in a rush to push their plan through quickly before there can be extensive analysis and a solid debate, there is enough now available to make reasonable estimates of the impact.  And so far, the changes adopted have been minor, with the basic structure of the original proposal maintained.  It remains a plan where the rich will benefit disproportionately.

The chart at the top of this post shows the estimated average cuts in taxes that would be provided under this plan, categorized by income group:  in quintiles plus for the top 1% and top 0.1%.  The quintile groups are defined by equal shares of the population (20%), with the bottom 20% in those households in the lowest income rank, and so on up to the richest 0.1%.  The breakpoints (in 2027, but in terms of prices of 2017) for household incomes for each group are:

a)  Bottom 20%:  $0 to $28,099 of annual income;

b)  Second 20%:  $28,100 to $54,699;

c)  Middle 20%:  $54,700 to $93,199;

d)  Fourth 20%:  $93,200 to $154,899;

e)  Top 20%:  $154,900 or more;

f)  Top 1%:  $912,100 or more;

g)  Top 0.1%:  $5,088,900 or more.

One would have to be earning over $900,000 a year (in 2017 prices) to be part of the top 1% in 2027, and over $5 million a year to be in the top 0.1%.  These groups are very well off.

As the chart shows, the cuts are overwhelmingly clustered at the top.  Indeed, the cuts are relatively so small for the first 80% of the population that they do not even register at all on the bar lines.  And even if one re-draws the chart to remove the tax cuts the top 0.1% would gain (which stretches the scale), there is not much of a difference:

One can still barely see the cuts that would go to the first 80% of the population.

However, supporters of the Republican plan respond by saying that the rich get most of the cuts because the rich pay most of the taxes.  It is true that the rich do pay more in the current system when expressed in absolute dollar terms.  (It is not always the case when the taxes are expressed as a share of their incomes, but that is a separate issue and one I will not go into here.)  But is it the case that the tax cuts that will go to the rich under the Republican plan are proportionate to their incomes and/or the taxes that they pay?  As we will see in the remainder of this post, they are not.

First, one can calculate from the TPC figures (available for 2027 for the groups analyzed here in spreadsheet form at this link) the share of the tax cuts (in total dollar terms) that will go to each of the income groups identified:

The rich will receive a much higher share, in dollar terms, of the tax cuts than would go to the others.  The richest 20% will receive 73% of the dollar value of the cuts, while the subset within this group that are the top 1% will receive 47% and the top 0.1% will receive 25%.

But how does this compare to their shares of overall income?  After all, if the top 20% receive 73% of the tax cuts, but also account for 73% of overall income, one could say the tax cuts are proportionate to their incomes.  But that is not the case:

 

The top 20% account “only” for 49% of the nation’s household incomes (as forecast for 2027), but will obtain 73% of the tax cuts (as also forecast for that year).  And one can look at the similar relative amounts for the other income groups.

Perhaps the argument would then be made that the tax cuts should not be compared to the income shares, but to the shares of taxes each group would be paying (before the tax cuts, as under current law).  There is still a degree of progressivity in the tax system, even though the progressivity was reduced sharply in the Reagan and Bush tax cuts.  For the shares of taxes that would be paid (under current law) in 2027, one can calculate:

 

But even here, the share of the top 20%, say, comes to 69%, which is still less than the share of the tax cuts (73%) they would receive under the Republican plan.  And the shares are far more disproportionate for the top 1% and especially the top 0.1%.

One can look at this systematically, for all groups, by calculating the ratio of the shares of the tax cuts which would go to each group, to the shares of what each group would be paying in taxes (under current law).  By definition, the average ratio will be 1.0 (weighted properly), but the individual ratios will be above or below this.  What we find by dividing the shares of the tax cuts (Chart 3 above) by the shares of taxes to be paid under current law (Chart 5) is:

 

The ratio of what the bottom 20% of the population will be receiving in the proposed tax cuts, to what they would be paying in taxes under current law, is only 0.4.  They would be receiving, under the Republican plan, a disproportionately low share of the cuts.  And the ratio is even worse for the second 20% (which one might consider as the lower middle class), at just 0.3.  At the other end of the scale, the ratio of what the top 1% will be receiving in the proposed tax cuts (47% of the cuts) to what they would be paying in taxes under current law (31% of the taxes) is very generous, at 1.5.  And the top 0.1% would enjoy a ratio of tax cuts to what would they pay in taxes under current law of an even higher 1.8.

Finally, what do the ratios look like if one compares the share of the tax cuts that would go to each group to the shares of the incomes of those groups?  For the purposes here, I have taken the incomes as they would be after taxes, but only after the taxes as they would be under current law.  This is the base one is starting from, and thus the basis for such a comparison.  One finds:

 

Here the ratios are even starker.  The ratio of the share of the tax cuts that would go to the bottom 20% (0.4% – see Chart 3), to the share of income of those in that group (5.3% – see Chart 4), is just 0.07.  Put another way, the share of the tax cuts that would go to the poorest 20% of the population is 93% below what it would be had the tax cuts been allocated equally according to income shares.  It is almost as low for the second 20%, at just 0.12 (or 88% below what it would be had the cuts been allocated equally according to income shares).  And the ratio remains below 1.0 for all but the top 20% of the population.

But the tax cuts are generous for those with high incomes.  For the top 1%, the share they would receive in the proposed tax cuts is over 3 times their share of income.  And it is 3.6 times as high for the top 0.1%.

It is nonsense to claim that this would be a “middle-class tax cut”, as the Trump administration and the Republican leadership in Congress have repeatedly asserted.  A dramatically disproportionate share of the cuts will go to the extremely rich, while those at the lower end of the distribution will receive only token amounts.

Social Security Could be Saved With the Revenues Lost Under the Trump Tax Plan

As is well known, the Social Security Trust Fund will run out in about 2034 (plus or minus a year) if nothing is done.  “Running out” means that the past accumulated stock of funds paid in through Social Security taxes on wages, plus what is paid in each year, will not suffice to cover what is due to be paid out that year to beneficiaries.  If nothing is done, Social Security payments would then be scaled back by 23% (in 2034, rising to 27% by 2091), to match the amount then being paid in each year.

This would be a disaster.  Social Security does not pay out all that much:  An average of just $15,637 annually per beneficiary for those in retirement and their survivors, and an average of just $12,452 per beneficiary for those on disability (all as of August 2017).  But despite such limited amounts, Social Security accounts for almost two-thirds (63%) of the incomes of beneficiaries age 65 or older, and 90% or more of the incomes of fully one-third of them.  Scaling back such already low payments, when so many Americans depend so much on the program, should be unthinkable.

Yet Congress has been unwilling to act, even though the upcoming crisis (if nothing is done) has been forecast for some time.  Furthermore, the longer we wait, the more severe the measures that will then be necessary to fix the problem.  It should be noted that the crisis is not on account of an aging population (one has pretty much known for 64 years how many Americans would be reaching age 65 now), nor because of a surprising jump in life expectancies (indeed, life expectancies have turned out to be lower than what had been forecast).  Rather, as discussed in an earlier post on this blog, the crisis has arisen primarily because wage income inequality has grown sharply (and unexpectedly) since around 1980, and this has pulled an increasing share of wages into the untaxed range above the ceiling for annual earnings subject to Social Security tax ($127,200 currently).

But Congress could act, and there are many different approaches that could be taken to ensure the Social Security Trust Fund remains adequately funded.  This post will discuss just one.  And that would be not to approve the Trump proposal for what he accurately calls would be a huge cut in taxes, and use the revenues that would be lost under his tax plan instead to shore up the Social Security Trust Fund.  As the chart at the top of this post shows (and as will be discussed below), this would more than suffice to ensure the Trust Fund would remain in surplus for the foreseeable future.  There would then be no need to consider slashing Social Security benefits in 2034.

The Trump tax plan was submitted to Congress on September 27.  It is actually inaccurate to call it simply the Trump tax plan as it was worked out over many months of discussions between Trump and his chief economic aides on one side, and the senior Republican leadership in both the Senate and the Congress on the other side, including the chairs of the tax-writing committees.  This was the so-called “Gang of Six”, who jointly released the plan on September 27, with the full endorsement of all.  But for simplicity, I will continue to call it the Trump tax plan.

The tax plan would sharply reduce government revenues.  The Tax Policy Center (TPC), a respected bipartisan nonprofit, has provided the most careful forecast of the revenue losses yet released.  They estimated that the plan would reduce government revenues by $2.4 trillion between 2018 and 2027, with this rising to a $3.2 trillion loss between 2028 and 2037.  The lost revenue would come to 0.9% of GDP for the 2018 to 2027 period, and 0.8% of GDP for the 2028 to 2037 period (some of the tax losses under the Trump plan are front-loaded), based on the GDP forecasts of the Social Security Trustees 2017 Annual Report (discussed below).  While less than 1% of GDP might not sound like much, such a revenue loss would be significant.  As we will see, it would suffice to ensure the Social Security Trust Fund would remain fully funded.

The chart at the top of this post shows what could be done.  The curve in green is the base case where nothing is done to shore up the Trust Fund.  It shows what the total stock of funds in the Social Security Trust Fund have been (since 1980) and would amount to, as a share of GDP, if full beneficiary payments would continue as per current law.  Note that I have included here the trust funds for both Old-Age and Survivors Insurance (OASI) and for Disability Insurance (DI).  While technically separate, they are often combined (and then referred to as OASDI).

The figures are calculated from the forecasts released in the most recent (July 2017) mandated regular annual report of the Board of Trustees of the Social Security system.  Their current forecast is that the Trust Fund would run out by around 2034, as seen in the chart.

But suppose that instead of enacting the Trump tax plan proposals, Congress decided to dedicate to the Social Security Trust Funds (OASDI) the revenues that would be lost as a consequence of those tax cuts?  The curve in the chart shown in red is a forecast of what those tax revenue losses would be each year, as a share of GDP.  These are the Tax Policy Center estimates, although extrapolated.  The TPC forecasts as published showed the estimated year-by-year losses over the first ten years (2018 to 2027), but then only for the sum of the losses over the next ten years (2028 to 2037).  I assumed a constant rate of growth from the estimate for 2027 sufficient to generate the TPC sum for 2028 to 2037, which worked out to a bit over 6.1%.  I then assumed the revenue losses would continue to grow at this rate for the remainder of the forecast period.

Note this 6.1% growth is a nominal rate of growth, reflecting both inflation and real growth.  The long-run forecasts in the Social Security Trustees report were for real GDP to grow at a rate of 2.1 or 2.2%, and inflation (in terms of the GDP price index) to grow at also 2.2%, leading to growth in nominal GDP of 4.3 or 4.4%.  Thus the forecast tax revenue losses under the Trump plan would slowly climb over time as a share of GDP, reaching 2% of GDP by about 2090.  This is as one would expect for this tax plan, as the proposals would reduce progressivity in the tax system.  As I noted before on this blog and will discuss further below, most of the benefits under the Trump tax plan would accrue to those with higher incomes.  However, one should also note that the very long-term forecasts for the outer years should not be taken too seriously.  While the trends are of interest, the specifics will almost certainly be different.

If the tax revenues that would be lost under the Trump tax plan were instead used to shore up the Social Security Trust Fund, one would get the curve shown in blue (which includes the interest earned on the balance in the Fund, at the interest rates forecast in the Trustees report).  The balance in the fund would remain positive, never dipping below 12% of GDP, and then start to rise as a share of GDP.  Even if the TPC forecasts of the revenues that would be lost under the Trump plan are somewhat off (or if Congress makes changes which will reduce somewhat the tax losses), there is some margin here.  The forecast is robust.

The alternative is to follow the Trump tax plan, and cut taxes sharply.  As I noted in my earlier post on this blog on the Trump tax plan, the proposals are heavily weighted to provisions which would especially benefit the rich.  The TPC analysis (which I did not yet have when preparing my earlier blog post) has specific estimates of this.  The chart below shows who would get the tax cuts for the forecast year of 2027:

The estimate is that 87% of the tax revenues lost under the Trump plan would go to the richest 20% of the population (those households with an income of $154,900 or more in 2027, in prices of 2017).  And indeed, almost all of this (80% of the overall total) would accrue just to the top 1%.  The top 1% are already pretty well off, and it is not clear why tax cuts focused on them would spur greater effort on their part or greater growth.  The top 1% are those households who would have an annual income of at least $912,100 in 2027, in prices of 2017.  Most of them would be making more than a million annually.

The Trump people, not surprisingly, do not accept this.  They assert that the tax cuts will spur such a rapid acceleration in growth that tax revenues will not in fact be lost.  Most economists do not agree.  As discussed in earlier posts on this blog, the historical evidence does not support the Trumpian view (the tax cuts under Reagan and Bush II did not lead to any such acceleration in growth; what they did do is reduce tax revenues); the argument that tax cuts will lead to more rapid growth is also conceptually confused and reveals a misunderstanding of basic economics; and with the economy having already reached full employment during the Obama years, there is little basis for the assertion that the economy will now be able to grow at even 3% a year on average (over a mulit-year period) much less something significantly faster.  Tax cuts have in the past led to cuts in tax revenues collected, not to increases, and there is no reason to believe this time will be different.

Thus Congress faces a choice.  It can approve the Trump tax plan (already endorsed by the Republican leadership in both chambers), with 80% of the cuts going to the richest 1%.  Or it could use those revenues to shore up the Social Security Trust Fund.  If the latter is done, the Trust Fund would not run out in 2034, and Social Security would be able to continue to pay amounts owed to retired senior citizens and their survivors, as well as to the disabled, in accordance with the commitments it has made.

I would favor the latter.  If you agree, please call or write your Senator and Member of Congress, and encourage others to do so as well.

————————————————————————

Update, October 22, 2017

The US Senate passed on October 19 a budget framework for the FY2018-27 period which would allow for $1.5 trillion in lost tax revenues over this period, and a corresponding increase in the deficit, as a consequence of new tax legislation.  It was almost fully a party line vote (all Democrats voted against it, while all Republicans other than Senator Rand Paul voted in favor).  Importantly, this vote cleared the way (under Senate rules) for it to pass a new tax law with losses of up to $1.5 trillion over the decade, and pass this with only Republican votes.  Only 50 votes in favor will be required (with Vice President Pence providing a tie-breaking vote if needed).  Democrats can be ignored.

The loss in tax revenues in this budget framework is somewhat less than the $2.4 trillion that the Tax Policy Center estimates would follow in the first decade under the Trump tax plan.  But it is still sizeable, and it is of interest to see what this lesser amount would achieve if redirected to the Social Security Trust Fund instead of being used for tax cuts.

The chart above shows what would follow.  It still turns out that the Social Security Trust Fund would be saved from insolvency, although just barely this time.

One has to make an assumption as to what would happen to tax revenues after 2027, as well as for what the time pattern would be for the $1.5 trillion in losses over the ten years from FY2018 to 27.  With nothing else available, I assumed that the losses would grow over time at the same rate as what is implied in the Tax Policy Center estimates for the losses in the second decade of the Trump tax plan as compared to the losses in the final year of the first decade.  As discussed above, these estimates implied a nominal rate of growth of 6.1% a year.  I assumed the same rate of growth here, including for the year to year growth in the first decade (summing over that decade to $1.5 trillion).

The result again is that the Social Security Trust Fund would remain solvent for the foreseeable future, although now just marginally.  The Trust Fund (as a share of GDP) would just touch zero in the years around 2080, but would then start to rise.

We therefore have a choice.  The Republican-passed budget framework has that an increase in the fiscal deficit of $1.5 trillion over the next decade is acceptable.  It could be used for tax cuts that would accrue primarily to the rich.  Or it could be used to ensure the Social Security system will be able, for the foreseeable future, to keep to its commitments to senior citizens, to their survivors, and to the disabled.

 

Lower Corporate Taxes Have Not Led to Higher Real Wages

A recently released report from the president’s Council of Economic Advisers (CEA) claims that cutting the headline corporate income tax rate from the current 35% to 20% would lead to a jump in the real incomes of American households by a minimum of $4,000 a year and possibly by as much as $9,000.  Others have criticized those forecasts for a variety of reasons, and Larry Summers has called the estimates “absurd”.

Indeed, they are absurd.  One way to see this is by looking at the historical evidence.  This is not the first time the US would cut its corporate tax rates.  Did such cuts in the past then lead to a jump in real wages?  As the chart above suggests, the answer is no.  This blog post will discuss that evidence, as well as other issues with the CEA analysis prepared under (and it appears largely by) its new chair Kevin Hassett.  But first some background on the CEA and its new chair, and what this recent incident portends for the Council and its previous reputation for professionalism.

The Council of Economic Advisers has, until now, been a highly respected office in the White House, set up to provide the president with objective and professional economic advice on the key economic issues of the day.  The Council was established in 1946 during the Truman administration, and has had as its chair and its members many illustrious and well-respected economists.  A number later received the Nobel Prize in Economics and similar awards.  While the CEA can be and has been political at times (it is located in the Office of the President, after all), it has had an able staff who were expected to provide professional assessments of the issues as a service to the president.  Many came on leave from academic posts.  As an example of the type of staff they could draw, both Larry Summers and Paul Krugman, then young and rising economists, were on the Council staff in the early 1980s during the Reagan administration.

The current chair is Kevin Hassett.  Trump did not nominate someone to the position until April, and Hassett took up his post (following Senate approval) only on September 13.  Prior to this post, Hassett was perhaps best known for co-authoring (with James K. Glassman) the 1999 book titled “Dow 36,000”, in which he forecast the Dow Jones Industrial Average would reach 36,000 by 2002 and certainly no later than by 2004.  In the event, the Dow never exceeded 11,750 (in January 2000) and dropped to 7,200 in October 2002, as the Bush administration’s first recession took hold.

Hassett has now, as one of his first official acts, released a formal CEA study that claims that if the Trump Tax Plan were enacted, with the headline corporate income tax cut from 35% to 20%, household incomes in the US would rise by a minimum of $4,000 per year, and possibly by as much as $9,000.  Larry Summers has termed it “dishonest, incompetent, and absurd”, and other economists have been similarly scathing.

The study really is pretty bad, and must be an embarrassment to the CEA staff. The report starts (Figure 1) with a chart that shows average real wage growth over the last several years (2013 to 2016) among the 10 OECD member countries with the highest statutory corporate income tax rates, as compared to that for the 10 OECD members with the lowest rates.  Between 2013 and 2016 (but essentially just in 2015) the wage growth was higher by a few percentage points in the set of OECD countries with the lower tax rates.  But the 10 OECD member countries with the lowest corporate tax rates were mostly countries from Central and Eastern Europe (Estonia, Latvia, and so on to Slovenia).  They were starting from lower wage rates than in the richer countries, and benefited as they opened up to globalization and in particular to the EU markets.  It is difficult to see how this simplistic correlation tells us much about what would happen if the US cut its corporate income tax rate.

Hassett then quantifies his estimate of the dollar gains per household by citing a number of obscure articles (several of which were never published in a peer-reviewed journal) to come up with estimates of possible elasticities (explained below) that relate how much household incomes would rise if corporate taxes were cut.  He concludes this review by asserting that an elasticity in the range of -0.16 to -0.33 would be reasonable, in his view.  The -0.16 figure came from a study from 2009 published in the “Federal Reserve Bank of Kansas City Economic Review”.  That is not exactly a prestigious journal.  And the -0.33 figure came from a 2007 paper that was presented at a conference, and does not appear to have ever been published.

An elasticity of -0.16 means that if the corporate tax rate were cut by 1% (not 1 percentage point, but rather by actually 1%, e.g. from 35% to 34.65%), then real wages would rise by 0.16%.  A 10% cut in the corporate tax rates (e.g. 35% to 31.5%) would lead, according to this assumption, to real wages rising by 1.6%.  And a cut in the corporate income tax rate from 35% to 20% (a 43% fall), as proposed in the Trump tax plan, would raise real wages by 6.9% under this assumption.  Hassett then applies this to the wage portion of household incomes to arrive at his calculated gain of $4,000 per household.  And the $9,000 gain is based on assuming an elasticity of -0.33.

There are numerous problems with this analysis, starting with the assumption that correlations are the same as causation.  There is also a question of what correlations are relevant.  The study that came up with the -0.33 elasticity, for example, looked at correlations across a panel of 50 countries.  It is not clear that such correlations would be of much relevance to judging the impact on real wages of a change in the US on corporate tax rates, as real wages across such a range of countries are driven by many factors (including, not least, the level of development).  And the -0.16 elasticity came from a study that examined correlations between real wages and corporate tax rates across the different states of the US.  But labor is mobile across US states, as is capital, plus the range of variation (state to state) in corporate tax rates is relatively modest as state taxes are relatively modest in size.  And indeed, it is not even clear how many companies actually pay the headline corporate income tax rates on the books, as states routinely grant them special tax holidays and other favors in order to try to get them to move to their states.

One would have thought that the most interesting investigation as to whether changes in corporate income taxes would matter in the US to real wages, would have been to see what actually happened in the US when such rates were cut in the past.  The fact that Hassett ignored this obvious question in the new CEA report is telling.  And there have indeed been earlier changes in the corporate tax rate, most notably (in recent decades) in 1987/88, following from the Tax Reform Act of 1986 during the Reagan administration.

The impact (or rather the lack of it) can be seen in the chart at the top of this post.  As had been discussed in earlier posts on this blog, real wages have been stagnant in the US (for the median wage earner) since around 1980.  The chart at the top of this post is an update of one prepared for a post from February 2015 that looked at the proximate causes of stagnant wages over this period, despite growth of real GDP per capita of more than 80% over the period.  While real GDP per capita is now 82% above what it was at the start of 1979, real wages (as measured by real median weekly earnings of full-time workers) are just 5.7% above where they were at the start of 1979.  Furthermore, the current “peak” of 5.7% growth can all be attributed to growth in the period since mid-2014, as the economy finally approached full employment levels in the later years of the Obama administration (having been held back by government spending cuts from 2010), with this carrying over into 2017.

The top corporate tax rate on profits was cut from 46% in the years up through 1986, to 40% in 1987 and then to just 34% in 1988 and thereafter to 1993 (when it was raised to the current level of 35%).  Did the cuts in 1987/88 lead to a sharp jump in real wages?  There is no indication of that at all in the chart.  Indeed, real wages fell by close to 6% between late 1986 and 1990, and then stayed at close to that low level until they started to rise some in the mid to late 1990s.  And there is no indication that the small increase in the corporate tax rate in 1993 to 35% led to wages then declining – indeed, they started to rise a few years later.

Based on this, one might come to the conclusion that a cut in corporate tax rates will lead to a fall (not an increase) in real wages, as seen following the 1987/88 cuts.  And also that a modest rise in the tax rate (such as in 1993) would lead to a gain in real wages a few years later.  But I would not claim this.  Rather, I would say that real wages and corporate tax rates are simply not closely linked to one another.  But for Hassett and others to claim that cuts in corporate taxes will lead to a significant jump in real wages, the exact opposite outcome following the 1987/88 cuts needs to be explained.

The CEA report was badly done, and must be an embarrassment to the professional staff there who certainly know better.  And as Larry Summers remarked in his blog post:  “Considering all this, if a Ph.D student submitted the CEA analysis as a term paper in public finance, I would be hard pressed to give it a passing grade.”