How Trump's tax cut plan would blow up the deficit
Tax and budgetary policy experts are divided on the impact that President Trump's proposal to slash the corporate income tax rate from 35 percent to 15 percent would have on the federal budget and the broader U.S. economy. Some think it would be bad. Others believe it could be catastrophic.
According to the Congressional Budget Office, the Treasury will take in about $3.4 trillion in tax revenue in 2017, the vast majority of it coming from the personal income tax and payroll taxes. Business taxes, estimated to total $320 billion this year, make up just 9.4 percent of total tax revenues. Trump's proposal, slashing the corporate rate by more than half, would drive the projected revenues from corporate taxes down to something more like $120 billion, or about 3.5 percent of total federal tax revenues.
While that may seem like a relatively small change, in a budget that is already in perpetual deficit that $200 billion gap in the first year (absent any yet-to-be-revealed plan to offset the cost of the plan with spending cuts or other revenue) would have to be financed by government borrowing, adding between $2 and $2.5 trillion to the national debt over a decade.
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One of the arguments that the Trump administration has floated with regard to its tax reform strategy is that tax cuts will pay for themselves by generating enough economic growth to raise tax revenue by an amount that offsets the cut. That's a notion that even conservative-leaning scholars aren't buying, at least in this case.
Alan Cole, an economist at the right-leaning Tax Foundation, ran the numbers and concluded that in order to pay for itself within the frame of a 10-year budget window, the administration's dramatic reduction in corporate taxes would need to generate 0.9 percent additional economic growth every year. That's growth on top of growth produced by other factors, resulting in an economy that is about 9 percent bigger at the end of a decade than it would have been without the corporate rate cut.
But according to the Tax Foundation's model, that's not likely to happen.
"The Tax Foundation's Taxes and Growth model would not predict 0.9 percent added growth over the budget window from a corporate rate cut to 15 percent," Cole wrote in a blog post scheduled to be published on Tuesday. "The model predicts something more like 0.4 percent over the budget window, reaching a final long-run change of 4.3 percent."
Barring a massive influx of immigrants -- something not likely under the anti-immigration Trump administration -- there just isn't a lot of room for extra growth in the U.S. economy. The country is at close to full employment, meaning that what will drive the most economic growth in coming years is a rise in productivity.
"Unfortunately," Cole explains, "productivity growth has relatively low variance, historically. It usually grows between 1 and 2 percent per year. Policy can probably help us stay towards the higher end of that range, but a single policy is unlikely to move productivity growth for the whole economy by a whole percentage point."
But failing to pay for itself could be less of a problem for Trump's tax cut than some of its other effects.
Adding $2.5 trillion to the federal debt over ten years would, all by itself, increase the debt by about 8 percent of U.S. GDP, according to Marc Goldwein, senior policy director at the Committee for a Responsible Federal Budget. And the follow-on effects on interest rates would make the increase even more dramatic.
Increasing federal borrowing by a large amount will, all things equal, put upward pressure on interest rates, leading to a rise in the percentage of federal outlays going to debt service. However, there will also be outside forces driving up rates, like the Federal Reserve Board's Open Market Committee, which has initiated a years-long plan to gradually push rates higher.
CBO already projects that federal interest payments will more than double over the next 10 years, from 1.3 percent of GDP to 2.7 percent. Adding trillions of additional debt to that figure would only drive that percentage higher.
Additionally, it is unclear right now just how broadly the new 15 percent rate would apply. The majority of small businesses in the U.S. are structured as pass-throughs, which means the owners pay personal income taxes on their profits.
Trump has, in the past, suggested that those businesses should also benefit from cuts to the corporate tax rate. CRFB's Goldwein said that if Trump means for his business tax cut to apply to pass-throughs as well, it would take an additional $1 trillion to $2 trillion out of the federal revenue stream over the next decade.
"This would be really expensive for a variety of reasons," Goldwein said. In addition to increasing borrowing costs, he said, it could drive what economists call income-shifting.
Currently, the top marginal tax rate for personal income tax filers is 39.6 percent. If owners of pass-through businesses are suddenly allowed to pay what amounts to a 15 percent flat rate on their income, there would suddenly be a lot more pass-through businesses in the U.S.
"I might quit my job here and start Marc Goldwein Consultants," Goldwein said. "I could charge the Committee for a Responsible Federal Budget a consulting fee and pay myself as a business so that I could pay the 15 percent rate."
The call for a major cut to business taxes also appears to signal that the administration is not interested in pursuing a wholesale change of how the U.S. taxes businesses by switching to a border-adjustable sales tax. The measure, popular among House leadership, would be similar to the sort of value-added tax common in Europe.
And jettisoning the House leadership's preferred plan won't be the administration's only problem with Congress if it moves forward with this plan.
The current objective, GOP leaders have said, is to fold tax changes into a budget resolution later this year, allowing the Republicans in the Senate to pass them as part of a budget reconciliation package.
However, Senate rules don't allow reconciliation bills to increase the deficit beyond a 10-year window, which means that even if Trump were successful in seeing his business tax cut passed, he would have to accept the fact that it would expire after 10 years.Top Reads from The Fiscal Times