In a speech on Wednesday, President Donald Trump laid out four principles for tax reform. Since there’s no actual tax reform bill yet, we can’t say how well it will serve those principles – but the outlook for Congress’ output matching Trump’s rhetoric is not promising.
Trump said tax reform should:
Simplify tax filing for individuals and eliminate advantages for wealthy people who can work the system; Encourage job creation and wage growth; Provide tax relief for middle-income people; Encourage multinational companies to bring money back to the United States and invest it.
Notably, none of these four principles has much to do with what’s likely to be one of the most expensive elements of any Republican tax bill: reducing personal income tax rates at the top of the income scale.
Republicans usually argue such rate cuts encourage rich people to invest in businesses and create jobs. But the results from the 2001 Bush tax cuts were not promising in that regard, and Trump himself even focused mostly on the need for cuts in business tax rates, not personal income tax rates.
Trump spent a lot of time on one specific, bad idea
Trump’s fourth principle seemed almost entirely aimed at arguing for what’s called a “repatriation holiday.”
Currently, US corporations are supposed to pay tax on their worldwide income at a rate of 35%. But in addition to many tax preferences that reduce the effective tax rates companies pay, US firms are allowed to delay tax on foreign profits as long as the money stays abroad.
Once companies do bring the money back, they’re supposed to pay 35%, less whatever they’ve paid overseas. As Trump correctly noted, other major countries have cut their corporate tax rates over the decades. So usually there is tax due if companies bring profits back, which creates a disadvantage for US-based multinationals compared to multinational firms based in countries that do not seek to tax global profits.
A repatriation holiday would allow (or require, depending on the specific design of tax reform) corporations to bring overseas profits back to the United States, while letting them pay a rate much lower than the full 35%. The idea is this will make it possible for money parked overseas to come back here and be invested in new factories and buildings and such.
But there are a few problems with this idea.
One is that a lot of the “foreign” profits of US multinational firms sitting abroad aren’t really foreign – and/or were not really taxed at a substantive rate in another country. Multinationals use elaborate accounting structures to conveniently show their profits were earned in tax havens, not in countries with high or even moderate tax rates.
Proponents of a repatriation holiday say it avoids double taxation of corporate profits, but a lot of the profits being repatriated will never have been materially taxed anywhere.
A second problem is that corporate tax cuts are supposed to encourage investment by reducing the tax rate investors will pay on their future investments. A tax holiday applicable to past profits provides a windfall to people who invested in corporations in the past; no tax policy, no matter how forceful, can create more investment in the past.
A third problem is that we tried repatriation in 2004, and it mostly led to companies paying dividends to shareholders, not making new investments.
This is partly because the sorts of firms with lots of accrued profits abroad that would benefit from a repatriation holiday (think Apple and Google) don’t need access to this money to make the investments they want. They have deep access to capital markets and can issue stock or bonds if they need new capital.
Trump’s principles are competing for a limited pot of money
- Thomson Reuters
Trump’s last three tax reform principles are expensive.
He wants to encourage job creation by cutting business tax rates.
He wants to provide middle-income tax relief, including through subsidies for child care, which he pointedly noted in the speech are important to his daughter, Ivanka. (Are they important to him, too? They’re not important to Republicans in Congress and are unlikely to end up in the final bill, Doug Holtz-Eakin of the conservative American Action Forum told me on KCRW’s Left, Right & Center earlier this month.)
He wants to do a repatriation holiday, plus allow corporations to forego tax on their foreign income in years going forward.
And, as I note above, he’s almost surely going to want to cut personal income tax rates on rich people even though he didn’t really talk about it on Wednesday. Former chief strategist Steve Bannon was a lonely voice in the White House calling for higher tax rates on high personal incomes, but he’s gone.
Offsetting tax hikes aren’t fun, but omitting them is a problem, too
There’s a limit to how much Republicans are going to be prepared to increase the deficit with a tax plan. Some Republicans in Congress are even still officially insisting they intend for tax reform to be revenue neutral, which by law it would have to be if they wish to make it permanent without 60 votes in the Senate.
If the tax cut plan is temporary, some provisions will have to expire after 10 years, which happened with the Bush tax cuts and led to higher rates on top earners by 2013 than were imposed before Republicans cut taxes in the first place in 2000.
But revenue neutrality would require finding some tax increases to offset the tax cuts Trump wants. And House Speaker Paul Ryan’s big idea for this – something called a business activity tax – is dead in the face of opposition from retailers and Republican senators.
Trump’s first principle is the one that could contain the revenue raisers: “simplification” could mean abolishing tax deductions and preferences.
I wrote earlier today about the tax deduction buzz saw Trump is likely to run into, which will make meaningful simplification very difficult.
As Mitt Romney learned the hard way, there’s less money available to raise through tax preference abolition than you might think, even before you get into the inevitable political opposition to eliminating preferences that are important to special interest groups and/or millions and millions of individual taxpayers.
Another way to simplify is another idea Trump has floated: Doubling the standard deduction, so fewer taxpayers find it appealing use itemized deductions, even if those deductions remain available. But instead of raising money, this would be a large tax cut. It would mostly benefit middle-income households and would do little to encourage hiring or work, because it would not cut marginal tax rates.
On the plus side, doubling the standard deduction would serve Trump’s first and third tax reform principles: simplification and middle-class tax relief. But since Republicans in Congress have two main goals (encourage economic growth and reward their rich supporters) they are likely to resist this expensive idea that would serve neither.
You can’t put lipstick on a pig that doesn’t exist
- Agence France-Presse/Mandel Ngan
On MSNBC Wednesday afternoon, Jared Bernstein, who used to be Vice President Joe Biden’s top economic adviser, said he was going to accuse the president of putting lipstick on a pig with his tax reform speech, but then he realized there’s no pig.
As long as the Republican tax reform plan doesn’t exist – and as yet, it doesn’t exist – we can’t say yet whether it lives up to the presumably-popular principles Trump laid out on Wednesday.
Once there is a tax bill, we’ll be able to tell how it balances tax cuts for the rich, for the sort-of-rich, for middle-income people, and for corporations. We’ll be able to make some assessments about how it might affect economic and job growth. (Probably not very much either way, if past tax reforms are a guide.) We’ll know what tax preferences it abolishes, who would win and lose from that, and how much it would really shorten the typical taxpayer’s tax filing. And we’ll be able to assess how it would affect the deficit.
The political and arithmetic constraints mean Trump and Republicans in Congress are unlikely to produce something satisfactory. But so far, they haven’t produced anything at all – and if the healthcare fight is any guide, the phase where they have to legislate is likely to be less fun for them than the phase where they just talk.
Will Trump get bored of tax reform?
I noted that Trump offered four principles about tax reform. But he got stuck on a long digression when laying out the second principle (job creation) in which he ranted about how terrible NAFTA is, and about the need for “strong borders” and outcompeting other countries.
Trump does not have a history as a tax reformer. In Wednesday’s speech, he praised the Tax Reform Act of 1986, but this is a law he’s hated for decades. “The Art of the Deal” contains a lot of whining about how the then-new law was going to destroy real-estate investment. After he nearly went bankrupt, he testified before Congress about the desirability of undoing parts of the law.
Trump said during the speech that he hopes Congress won’t let him down on taxes – alluding to, but not specifically mentioning, how they let him down on healthcare. But tax reform is a complex political matter where presidential leadership can help overcome the inevitable opposition to various provisions from various interest groups.
And if Trump doesn’t really care about the details – and wishes he could talk about trade or immigration or how unfair the media is – then tax reform is likely to go the way healthcare repeal did: poorly.