In case you missed it over the weekend, Cato scholar Ryan Bourne wrote about the Republican tax reform plan in an op-ed featured in The Hill. He responds to the argument that corporations will use money saved from the reduction in the federal corporate tax rate to increase dividends, buy back shares, or other strategies that benefit their shareholders. 

Major companies, including Cisco Systems, Pfizer and Coca-Cola, have said they will use most of the gains from proposed corporate rate cuts to increase dividends to shareholders or buy back their own shares. This has been reported and shared on Twitter as a slam dunk against the Republican tax plan.

After all, a major claim of the administration has been that corporate rate cuts would benefit workers through wage rises, rather than flowing exclusively to capital owners.

Yet, the reaction of these companies is nothing unexpected, at least in the short term. Any substantial cut to the corporate rate provides an immediate windfall to so-called “old capital.”

But even though the initial beneficiaries of changes in the corporate tax rate will indeed be corporate shareholders, Bourne points out that those savings have to go somewhere. 

If existing firms have excess capital in the short-term, distributing it to shareholders in some way makes sense. This money is unlikely to sit dormant afterwards. In all likelihood, that money will be deployed elsewhere to find new value.

The market for growth industries through venture capital and angel investment is huge, and these windfalls can be invested in the start-ups and industries of the future.

The key point though is that the lower corporate rate improves the after-tax profitability of investment across the economy, and as such generates new activity. Other things given, domestic companies will have greater incentive to invest.

Foreign companies will be more likely to expand their investments in the U.S. — or even shift their operations here. U.S. companies will repatriate profits earned by their foreign subsidiaries rather than leaving them abroad, and more capital will flow from other less productive U.S. sectors into the U.S. corporate world. 

Read the op-ed here. 

Democrats have been relentlessly attacking the pro-growth elements of the GOP tax bills, such as the corporate tax rate cuts. They label efforts to improve incentives for working and investment as “trickle-down economics.”

Here are some recent examples:

• Sen. Pat Leahy (here): “Even these huge corporate tax cuts are not structured in a way that would truly encourage investments here at home and boost workers’ wages.”
• Sen. Kirsten Gillibrand (here): “After the tax plan was released, a lot of talking heads on TV dredged up the talking points about the virtues of “trickle-down economics”—the myth that if only corporations had more money, it would help everyday American families.”
• Rep. Tim Ryan (here): “Instead of fixing our broken tax system, the so-called tax ‘reform’ legislation the Republican Majority just rushed through the House relies on the same supply-side, trickle-down economics that has failed in the past.”
• Rep. Nancy Pelosi (here): “Their trickle-down economics has always been in their DNA. It has never created jobs…”

The House and Senate tax bills include numerous provisions that will not spur growth. But there are plenty of supply side elements as well, and they received support in yesterday’s Joint Committee on Taxation (JCT) dynamic modeling report.

Here are a few findings:

• “Overall, the net effect of the changes to the individual income tax is to reduce average tax rates on wage income by about one percentage point, while reducing effective marginal tax rates on wages by about 2.4 percentage points.” The marginal rate cuts “provide strong incentives for an increase in labor supply.”
• “The projected increase in GDP during the budget window results both from an increase in labor supply, in response to the reduction in effective marginal tax rates on wages, and from an increase in investment in response to the reduction in the after-tax cost of capital.”
• “The macroeconomic estimate projects an increase in investment in the United States, both as a result of the proposals directly affecting taxation of foreign source income of U.S. multi-national corporations, and from the reduction in the after-tax cost of capital in the United States due to more general reductions in taxes on business income.”

So the JCT views GOP efforts to reduce marginal tax rates and improve investment incentives with favor. The problem is that many of the proposed tax changes would add to deficits and not spur growth, combined with the JCT’s off-base assumptions about “crowding out.” The JCT assumes large reductions in investment as deficits from tax cuts supposedly raise interest rates.

J.D. Foster challenges those assumptions here. He notes, “The national debt doubled, and then doubled again, under President’s George W. Bush and Barack Obama, respectively, while real interest rates remain astounding low.” Despite that, the JCT assumes that a modest increase in borrowing for tax cuts would raise interest rates so much that it would choke off investment.

That does not make sense. The solution is to combine tax cuts with spending cuts to limit deficits, and to focus more of the tax changes on pro-growth reforms.

Republicans are scrambling to adjust their tax bill to satisfy concerns of lawmakers worried about budget deficits. The Joint Committee on Taxation (JCT) released a report yesterday finding that the government would lose $1 trillion over a decade in revenue even including the dynamic growth effects. Numerous economists (e.g. here and here) have criticized the JCT’s modeling for undercounting the growth benefits.

Still, the JCT’s $1 trillion figure is within the $1.5 trillion that Republicans allotted themselves for the tax bill. So it is surprising that some senators are moving the goalposts and demanding more revenue. But adding triggers or tax increases makes little sense because rising deficits in coming years will be mainly driven by rising spending, not revenue shortfalls—with or without a tax bill.

The chart below shows CBO’s baseline projections of spending and revenues as a share of gross domestic product (GDP). Revenues (red line) are set to rise from 17.7 percent of GDP this year to 18.4 percent by 2027, while outlays (blue line) will jump from 20.5 percent to 23.6 percent. Revenues creep upwards partly because of “real bracket creep” as people move into higher tax brackets. The chart clearly shows that deficits will rise because of rapid spending growth.

The green line shows revenues including the JCT’s projected effects of the Senate tax bill. Revenues fall in the short run, then rise as a result of numerous tax breaks expiring, and as the economy expands modestly per the JCT estimate. The Senate bill would add debt in the near term, but by year 10 would begin reducing deficits.

Even with the JCT’s lowballed growth estimates, projections show that spending restraint is the key to deficit reduction. Rather than adding tax increases, deficit worriers in the Senate should work to replace no-growth provisions in the tax bill, such as child credits, with pro-growth provisions, such as further rate cuts. And rather than holding up the tax bill, they should redouble their efforts in the new year to cut discretionary spending and reform entitlement programs.

Note: the green line is rough estimate as the JCT does not breakout dynamic revenue effects from its estimate of spending increases due to a rising interest rate.

It’s obviously too early to spike the football, but there is a provision in both the Senate and House tax bills that everyone should be able to endorse, except maybe colleges and their athletics departments: eliminating the 80 percent federal tax deduction college sports season ticket holders get when they pay “seat license” fees—often called “charitable gifts”—charged by schools. It’s an absurd deduction that I’ve complained about periodically, and it’s nice to see it targeted for elimination. And in case we need a reminder that this deduction has zilch to do with the “public good” that higher ed so often gives as its excuse for every special treatment it demands, USA Today has reported that this season 12 big football schools alone are on the hook for at least $70 million to buy out fired head coaches. Sounds like a lot of private good there.

These days it seems like we on Team America can’t agree on anything, but we all ought to agree on this: the seat license deduction must go.

Fiscal rules can theoretically improve policy by eliminating “time inconsistency” among lawmakers. But the proposed fiscal trigger being discussed in the Senate tax reform bill would be a terrible fiscal rule.

You can see the thinking. Several senators worry about tax cuts blowing a big hole in the public finances. If they do not have the desired impact on economic growth, resulting in less revenue than expected, the budget deficit will grow and drive the national debt even higher. Concerned senators therefore seek a mechanism whereby if revenues are lower than expected, tax cuts will be partially reversed.

It’s welcome that some senators take the US federal government’s burgeoning national debt seriously. But there are obvious flaws with this plan (though we do not know details as yet), some of which have been discussed widely already.

First, how exactly will deviations in revenues be judged? An economy is a complex organism, and it is difficult to disentangle how much any change in revenue relative to forecasts is due to changes in tax rates as against other factors. Just look at the debate in the UK. Last week, the Daily Mail newspaper published a report that tax receipts following corporate tax cuts there had been much higher than expected. But experts from the Institute for Fiscal Studies pointed out that much of this was due to a faster recovery of corporate profits in the financial sector and the effects of Brexit, which had little to do with the changing rate. Under a trigger which merely judged revenues against forecasts, a host of things that affect revenues (both upwards and downwards) could be chalked up as the effects of tax policy, potentially resulting in damaging tax rises.

Then, as J.D. Foster notes, there are likely to be other tax policy changes and changes in growth forecasts in future years too. How will these be disentangled and the effects of this specific Act isolated? Will the trigger apply to just a particular revenue stream, such as corporate income tax revenues, or more broadly to capture all the spillovers of any investment boost? If the former, the probability that the trigger will be activated is highly dependent on the accuracy of any analysis of the incentives to incorporate versus operating as a passthrough. In other words, there are huge unknowns here.

Second, the inclusion of a trigger mechanism actually dampens the pro-growth effects of the tax plan, and risks lower-than-expected revenues becoming a self-fulfilling prophecy. Take corporate rates. On the margin, uncertainty about what the corporate rate might be in the long term deters investments today. Less investment today results in lower GDP and lower tax revenues elsewhere in the code. This lower-than-expected tax revenue then activates the trigger (if it applies across total revenues) which raises corporate taxes. There is good reason why economists say that tax policy should provide certainty and permanence in regard to rates. The GOP plan already has a lot of phase outs resulting from the Senate reconciliation rules. The last thing it needs is the risk of more.

Third, you do not need to be a Keynesian to recognize that an unforeseen recession, which would dampen revenues relative to forecast, would be a terrible time to worsen supply-side incentives by increasing the corporate income tax or marginal income tax rates. In truth, Congress would likely override the trigger in such circumstances. But if the trigger would simply be abandoned when it bound, then it suggests it is not a very well-designed trigger! Of course, there could be a recession escape clause, but similar logic applies more broadly if the economy grows more slowly than expected, due to reasons other than tax reform changes.

In short, a fiscal trigger that threatened higher taxes would introduce considerable uncertainty, risk tax hikes at the worst possible time, and could risk tax hikes when other factors resulted in lower revenue growth. 

The distribution effects of the Senate tax bill are examined in a Washington Post story. Reporter Heather Long looks at the bill’s Obamacare mandate repeal, based on a new Congressional Budget Office (CBO) study.

A table in the study appears to show, “The Senate Republican tax plan gives substantial tax cuts and benefits to Americans earning more than $100,000 a year, while the nation’s poorest would be worse off.”

But as Long notes,

The main reason the poor get hit so hard in the Senate GOP bill is because the poor would receive less government aid for health care….The CBO and JCT analyses make it seem as if a family is actually getting money taken away from them, but in reality, most of these families making under $30,000 don’t pay any income tax. The credits and subsidies they received to help them buy health insurance were typically sent directly from the government to the insurance company. So these families are unlikely to see any changes to their tax bills.

Along with the CBO table, Long presents a Joint Committee on Taxation (JCT) table sent to her by Senate GOP staff showing the tax bill’s effects without the Obamacare piece. This table indicates across-the-board tax cuts in the early years, but is in aggregate dollars with no context.

I add context in the table below. The first column shows current law individual and corporate income taxes in 2019, based on my estimates discussed here. (JCT does not post online current law income taxes for 2019). The second column shows the dollar cut amounts—without the Obamacare part—from the JCT/​Washington Post table.

The third column shows the percentage cuts. Households at the bottom do not pay income taxes in aggregate, so they are “n/​a.” Under the Senate tax plan in 2019, middle-income households would receive much larger percentage cuts than higher-income households.

Given the (unfortunate) political importance of distribution tables, the JCT should post a fuller and more neutral set of such tables online.

The current tax reform debate has focused on economic growth and the value of cuts to different groups of taxpayers. Tax simplification has received less attention, and Republican bills would only make modest gains in that regard.

Yet a major tax code simplification would not only save time on administration, it would increase financial privacy and deter cyberattacks on the Internal Revenue Service. A new study by Michael Hatfield of the University of Washington looks at the risks posed by the IRS’s vast data collection on 290 million Americans. The more micromanagement there is in the tax code, the more information the IRS collects on our finances, lifestyles, and activities.

Here are some of Hatfield’s points:

• Many federal agencies have been hit with damaging cyberattacks in recent years, including the Office of Personnel Management, the Justice Department, the Pentagon, and the White House.
• The IRS has also suffered attacks. In 2015, “the IRS launched the Get Transcript service, enabling taxpayers to view this information (known as a “transcript”) online. Unfortunately, the security of the service was so low that, within the first few months of the service, hackers stole personal information from about 724,000 taxpayer accounts.”
• Individual hackers, groups, and hostile governments regularly target U.S. companies and government agencies. The Chinese government may be building a database of personal information on all Americans. The IRS is an ideal target for hackers seeking to steal personal information and money, and for people simply wanting to wreak havoc by destroying data.
• The IRS has a history of expensive technology failures. The agency has struggled to update its systems with new technologies and security protections. The IRS has a hard time competing to attract top computer experts, and so it may fall further behind.
• The IRS collects information on our income sources, family structure, health information, housing data, small business details, educational situation, retirement finances, and many other things. During investigations and audits, the agency can demand and collect just about any information it wants to judge the accuracy of tax return data.
• Political pressures work against security and personal privacy. Politicians encourage the IRS to improve “customer service,” which encourages more online interaction. And politicians push to close the “tax gap” of taxes owed but not collected, which prompts the agency to demand ever more data from individuals and businesses.

Hatfield notes that ensuring good cybersecurity is a difficult task for any agency these days, so damaging attacks against the IRS seem likely. Ironically, massive IRS attacks may have been avoided thus far due to the antiquated nature of the IRS’s computer systems.

We need better IRS management, but Hatfield’s main point is that Congress should simplify the tax code to reduce the amount of information collected from Americans. Another problem he points to is the overwithholding of income taxes, which necessitates more than 110 million refunds each year. Hatfield says, “making the IRS less like an ATM would reduce its appeal to financial thieves.” One fix, in my view, would be to repeal the earned income tax credit, which pays $60 billion in subsidies to more than 25 million people a year. The huge EITC error rate illustrates the IRS’s inability to monitor its vast transactions.

Hatfield concludes:

Congress has designed a tax system that requires the IRS to collect information on hundreds of millions of individuals and to routinely issue hundreds of billions in refunds. If the tax law did not require so much information on so many, nor involve refunds to so many, the IRS would be a less appealing and more defensible cyberattack target. In short, if the tax law were simpler in specific ways, the information technology needs at the IRS would be simpler, and adequate cybersecurity for it would be easier.

The tax law need not demand so much information on so many individuals, nor must its administration turn on a system that generates refunds as a rule rather than an exception. Within the limits of the political and financial realities that determine legislation, there is ample flexibility for Congress to reform tax law so that it demands less of both taxpayers and tax administrators and, thereby, provides more information security.

A broader conclusion from Hatfield’s study is that policymakers should put much more emphasis on personal privacy when considering all federal programs. The government has a poor record of guarding its databases, so policymakers should be very skeptical of federal activities that require the gathering of personal data on Americans.