The American Public Transit Association (APTA) has a new report on the economic impact of President Trump’s proposal to stop wasting federal dollars on digging holes and filling them up. Actually, the report is about Trump’s proposal to stop wasting federal dollars building streetcars, light rail and other local rail transit projects, but the two have almost exactly the same effect.

The APTA report says that digging holes and filling them up would provide about 500,000 jobs (though it really means job-years, that is, 500,000 jobs for one year). Since APTA says it would take ten years to dig and fill the holes that Trump wants to stop funding, that’s 50,000 jobs a year.

However, nobody wants a job digging holes and filling them up. What they want is income. Since there is no market for refilled holes, the only source of income for digging and filling holes is tax dollars. So what APTA really wants Congress to do is take money away from workers and then give it back to them and call it jobs. That’s not very productive.

The APTA report also says that refilled holes create economic development that will generate another 300,000 more jobs (which again really means job-years). Supposedly, people like living, shopping, and working next to refilled holes and so they will clamor to have homes, stores, and offices built next to those holes.

I don’t believe that’s true, but let’s say it is. If we don’t dig and refill the holes, people will still need to live, shop, and work somewhere. So the homes, stores, and offices will still be built, though (if you believe in the hole-location theory) they might be built in some part of the city other than next to the undug holes. Thus, digging holes creates zero net secondary jobs.

In fact, digging and refilling holes probably creates negative secondary jobs for the cities digging them because someone has to pay for those holes. The federal capital grants program only pays half the cost of digging and refilling the holes, and the locals have to pay for the rest. After the holes are dug, local taxpayers have to pay most of the cost of maintaining the refilled holes as settling is likely to occur. The local construction and maintenance costs put a huge burden on the local tax base, and some businesses are likely to locate in a city that isn’t obligated to pay for such holes.

In comparing streetcars, light rail, and other forms of rail transit to holes, some people might think I am unfair to holes. After all, holes don’t require annual operating costs like rail transit, and their maintenance costs are also a lot lower. For example, Washington DC used federal dollars to dig some holes and put trains in them, and now it faces a $25 billion maintenance backlog. If they had just left the holes empty, or filled them with dirt–or better yet not dug them at all–they wouldn’t have to worry about who is going to pay for that backlog.

As Will Rogers once said, “If you find yourself in a hole, stop digging.” The rail transit construction of the past 50 years has dug a huge hole that has cost taxpayers hundreds of billions of dollars and coincided with (and arguably contributed to) a decline in per capita transit ridership.

Whether we are talking about holes or building rail transit, the effect is the same. APTA wants Congress to take money from taxpayers so it can give it back to them and claim it is giving them jobs. APTA also wants local governments to take money from taxpayers so they can claim they are making cities more productive. But neither holes nor rail transit produce the income needed to sustain jobs nor do they make urban areas more economically productive. All they do is enrich a few contractors while adding to the overall tax burden. That’s why I think Trump’s policy of ending federal support to holes and other strictly local projects is a good idea.

In a column in today’s New York Times, Steven Rattner attacks Trump’s tax plan for being unrealistic. Since I also think the proposal isn’t very plausible, I’m not overly bothered by that message. However, Rattner tries to bolster his case by making very inaccurate and/​or misleading claims about the Reagan tax cuts.

Given my admiration for the Gipper, those assertions cry out for correction. Starting with his straw man claim that the tax cuts were supposed to pay for themselves.

…four decades ago…the rollout of what proved to be among our country’s greatest economic follies — the alchemistic belief that huge tax cuts can pay for themselves by unleashing faster economic growth.

Neither Reagan nor his administration claimed that the tax cuts would be self-financing.

Instead, they simply pointed out that the economy would grow faster and that this would generate some level of revenue feedback.

Which is exactly what happened. Heck, even leftists agree that there’s a Laffer Curve. The only disagreement is the point where tax receipts are maximized (and I don’t care which side is right on that issue since I don’t want to enable bigger government).

Anyhow, Rattner also wants us to believe the tax cuts hurt the economy.

…the plan immediately made a bad economy worse.

This is remarkable blindness and/​or bias. The double dip recession of 1980–1982 was the result of economic distortions caused by bad monetary policy (by the way, Reagan deserves immense credit for having the moral courage to wean the country from easy-money policy).

But even if one wants to ignore the impact of monetary policy, how can you blame the second dip of the recession, which began in July 1981, on a tax cut that was signed into law in August 1981?!?

Moreover, while Reagan’s tax cut was adopted in 1981, it was phased in over several years. And because of previously legislated tax increases, as well as inflation-driven bracket creep (prior to 1985, households were pushed into higher tax brackets by inflation even though their real income did not rise), the economy did not enjoy a tax cut until 1983. Not coincidentally, that’s when the economy began to boom.

Rattner even wants us to believe the Reagan tax plan caused higher interest rates.

…the Reagan tax cut increased the budget deficit, helping elevate interest rates over 20 percent, which in turn contributed to the double-dip recession that ensued. The stock market fell by more than 20 percent.

The deficit jumped mostly because of the double-dip recession, just as red ink always climbs when there is an economic downturn.

And interest rates were high largely because inflation was so high (lenders don’t like to deliberately lose money).

But the most amazing part of the above excerpt is that Rattner wants us to believe the Reagan tax cuts caused the part of the double-dip recession that occurred in 1980, when Jimmy Carter was still president.

That’s sort of like Paul Krugman trying to imply that Estonia’s 2008 recession was caused by spending cuts that took place in 2009!

You also won’t be surprised to learn that Rattner selectively likes Keynesianism.

Big deficits can sometimes be advisable, as they were in aiding recovery from the 2009 recession.

I guess he wants us the applaud Obama’s so-called stimulus and be impressed by the very anemic recovery that followed.

But we’re supposed to overlook the booming economy of the Reagan years.

Last but not least, it’s noteworthy that Rattner — in spite of his bias — endorses part of the Trump tax plan.

I understand our need to lower the corporate tax rate to compete with other countries and adjust other provisions to keep companies and jobs here. Critics are correct that our business-tax structure encourages companies to ship jobs and even themselves overseas.

And when even folks like Rattner realize that the current corporate tax system is indefensible, that explains why I’m semi-hopeful that we’ll get a lower rate at some point in the near future.

Now let’s look at broader lessons from the Reagan tax cuts.

Lesson #1: Lower Tax Rates Can Boost Growth

We can draw some conclusions by looking at how low-tax economies such as Singapore and Hong Kong outperform the United States. Or we can compare growth in the United States with the economic stagnation in high-tax Europe.

We can also compare growth during the Reagan years with the economic malaise of the 1970s.

Moreover, there’s lots of academic evidence showing that lower tax rates lead to better economic performance

The bottom line is that people respond to incentives. When tax rates climb, there’s more “deadweight loss” in the economy. So when tax rates fall, output increases.

Lesson #2: Some Tax Cuts “Pay for Themselves”

The key insight of the Laffer Curve is not that tax cuts are self-financing. Instead, the lesson is simply that certain tax cuts (i.e., lower marginal rates on productive behavior) lead to more economic activity. Which is another way of saying that certain tax cuts lead to more taxable income.

It’s then an empirical issue to assess the level of revenue feedback.

In the vast majority of the cases, the revenue feedback caused by more taxable income isn’t enough to offset the revenue loss associated with lower tax rates. However, we do have very strong evidence that upper-income taxpayers actually paid more to the IRS because of the Reagan tax cuts.

This is presumably because wealthier taxpayers have much greater ability to control the timing, level, and composition of their income.

Lesson #3:Reagan Put the United States on a Path to Fiscal Balance

I already explained above why it is wrong to blame the Reagan tax cuts for the recession-driven deficits of the early 1980s. Indeed, I suspect most leftists privately agree with that assessment.

But there’s still a widespread belief that Reagan’s tax policy put the United States on an unsustainable fiscal path.

Yet the Congressional Budget Office, as Reagan left office in early 1989, projected that budget deficits, which had been consistently shrinking as a share of GDP, would continue to shrink if Reagan’s policies were left in place.

Moreover, the deficit was falling because government spending was projected to grow slower than the private sector, which is the key to good fiscal policy.

Lesson #4: Lower Tax Rates Are Just One Piece of a Larger Puzzle

Having just disgorged hundreds of words on the importance of lower tax rates, let’s close by noting that fiscal policy is just one of many factors that determines an economy’s performance.

Indeed, tax and budget issues only account for 20 percent of a nation’s economic performance according to Economic Freedom of the World.

So it’s quite possible for a nation to be relatively free even with a bad tax system, and it’s also possible for a country to be economically repressed if it has a good tax system.

And this explains why economic freedom increased in America during the Clinton years, notwithstanding the 1993 tax hike. Simply stated, it’s the overall policy mix that matters.

I’ll conclude by noting that aggregate economic freedom in America increased during the Reagan years.

And the biggest reason for the increase was better fiscal policy.

It’s possible that we may also get more economic freedom during the Trump years. Indeed, I gave him a decent score for his first 100 days.

But it takes a lot of political courage to consistently fight for economic liberty in a town that cheers statism. And even though there’s a strong case to be made that there are political benefits to good policy, I’m not overly optimistic that Trump will be another Reagan.

According to former Reagan adviser Martin Feldstein, “Higher projected budget deficits could raise long-term interest rates, potentially triggering… a serious economic downturn.”

Has that ever happened?

From 1977 to 1981 10-year bond yields nearly doubled, rising from about 7.4% to 13.9%, but budget deficits were relatively small, around 2.5% of GDP. Budget deficits were doubled from 1984 to 1993 (about 5% of GDP), yet bond yields were nearly cut in half, falling from 12.4% to 5.9%. Bond yields were no lower from 1997 to 2000 when the budget moved into surplus. But yields fell dramatically in 2008–2012, a period of record budget deficits.

One possible objection is that larger budget deficits were caused by recessions, which is why bond yields did not rise with larger deficits or fall with surpluses. The graph addresses this concern by using CBO estimates [.xls] of cyclically-adjusted budgets (“with automatic stabilizers,” in CBO vocabulary). 

Still, there is clearly no correlation between bond yields and any measure of yearly budget deficits and surpluses. And that is also true in other times and places – Japan’s chronic large deficits and debt being an obvious example.

Another possible objection centers on Feldstein’s use of the phrase “projected budget deficits,” as though the CBO’s notoriously inaccurate long-run projections could somehow have an entirely different effect from actual deficits. I criticized the analysis and evidence behind that conjecture in a Treasury Department presentation which was condensed and simplified in a Cato Institute paper. I found the underlying analysis illogical and contradictory and the evidence worthless.

There is no need to make up stories about alleged effects of deficits on bond yields in order to make a strong case for minimizing frivolous government borrowing (e.g., to pay for transfer payments or government employee compensation).

Chronic deficits add to accumulated debt, and that debt will have to be serviced with future taxes even if it is rolled-over indefinitely. That is reason enough for Congress to keep growth of federal spending below the growth of the private economy – a task which requires frugality in spending but also a tax and regulatory climate which minimizes impediments to investment, entrepreneurship, education and work.

The Trump administration has released proposals to guide the Republican push for major tax reform. The proposals are mainly supply side in nature, meaning cuts to marginal tax rates and other changes designed to increase economic growth. Major tax reforms are needed desperately, so kudos to Trump for taking charge and thinking boldly, particularly on business tax reforms. There are, however, a few misguided parts in his new plan.

Here are thoughts on the proposed business tax reforms:

• Cutting the corporate tax rate from 35 percent to 15 percent would have a huge positive effect on the U.S. economy over time. It would encourage more capital investment and hiring, and it would reduce the incentive for corporations to avoid and evade taxes. Such a rate cut would cause the income tax base to expand automatically and substantially over time.
• Cutting the tax rate on “pass-through” businesses to 15 percent, however, is a mistake. Policymakers should aim to equalize the overall rates on income earned by each type of business. So if the corporate rate is 15 percent, corporate income would face a combined tax rate of 15 percent plus the individual dividend rate of, say, 15 percent under tax reform, for a total of about 28 percent (0.15+0.85*0.15). Thus, the top rate on pass-through income should be cut to the same 28 percent.
• Switching from a worldwide to a territorial system for corporations would encourage multinationals to move their headquarters to the United States. It would reverse the trend toward reincorporating abroad.
• Ditching the misguided “border adjustment” provision the House proposed is a good move. Paul Ryan and Kevin Brady need to drop it so that tax reform can move ahead.

Here are thoughts on the proposed individual reforms:

• Reducing the number of tax brackets from 7 to 3 (10, 25, and 35 percent) is a good reform. Cutting marginal rates reduces distortions, increases incentives to engage in productive activities, and reduces avoidance and evasion.
• Repealing the special 3.8% investment tax is a good reform.
• Eliminating itemized deductions—such as the state/​local tax deduction—is a good reform. But we should also eliminate, or at least cap, the mortgage interest deduction.
• Expanding child care benefits is a mistake. It would add complexity and distortion to what should be a private area of activity in the economy.
• Ending the alternative minimum tax and the estate tax are both long overdue reforms.

What about the effects of tax reform on the deficit? Policymakers should put that concern aside for the corporate rate cut portion of Trump’s plan because the automatic expansion of the corporate tax base would mean that the government would lose little if any revenue over the long term. Exhibit A: Canada and Exhibit B: Britain.

However, policymakers should be concerned about the deficit effects of individual tax changes. Optimally, the budget impact of reduced individual tax rates should be offset by eliminating deductions and credits, spending cuts, and dynamic growth effects.

All in all, the Trump proposals push tax reform in a good direction. Trump, his advisors, and House leaders seem to understand the urgency of passing major tax reforms. But we need Republican senators to step up to the plate and think boldly as well. Republicans have an opportunity this year to pass reforms that would generate large and lasting benefits in terms income and opportunity for every American family.

The Congressional Budget Office has released a report on compensation of federal government workers. It finds that compensation is 17 percent higher, on average, for federal civilian workers than for private sector workers, after adjusting for factors such as education levels.

The CBO found that federal wages were a little elevated, but that federal benefits were substantially higher than benefits in the private sector. Generally, less-skilled and medium-skilled workers do better on both wages and benefits in the government, but the highest-skilled workers do better on wages in the private sector.

Wages are 3 percent higher in the government than the private sector, on average, but the CBO finds substantial variation depending on education level:

• Federal workers with no more than a high school education earned 34 percent more, on average, than similar workers in the private sector.
• Federal workers whose highest level of education was a bachelor’s degree earned 5 percent more, on average, in the federal government than in the private sector.
• Federal workers with a professional degree or doctorate earned 24 percent less, on average, than their private-sector counterparts.

Benefits are 47 percent higher in the government, on average, but there is variation as follows:

• Average benefits were 93 percent higher for federal employees with no more than a high school education than for their private-sector counterparts.
• Average benefits were 52 percent higher for federal employees whose highest level of education was a bachelor’s degree than for similar private-sector employees.
• Among employees with a doctorate or professional degree, by contrast, average benefits were about the same in the two sectors.

The Trump administration and Congress should try to bring federal pay and workplace conditions in line with the rest of the nation. Reforms should include cutting the overly generous federal benefits package and reducing the hurdles to firing poorly performing federal workers.

For further analysis on federal wages, benefits, and firing, see here.

President Donald Trump and congressional Republicans are proposing to cut the corporate tax rate. With any tax cut, members of Congress want to know how much revenue the government may lose from the reform. I do not think that cutting our 35 percent federal corporate tax rate to 20 percent or so would lose the government any money over the long term. U.S. and foreign corporations would invest more in the United States, which would boost our economy, and corporations would avoid and evade taxes less.

Canada provides us with a real-world trial run of corporate tax cuts, and new budget data includes the latest revenue estimates. The nation slashed its federal corporate tax rate from 38 percent in the mid-1980s, to 29 percent by 2000, to 15 percent by 2012, as shown in Chart 1 below. Has the government lost revenue?

You be the judge. Chart 2 shows that corporate tax revenues in Canada have fluctuated with the ups and downs in the economy—revenues fell, for example, during recessions in the early 1990s and 2009. But even with the modest Canadian economic growth of recent years, revenues have held up under a much lower rate. Corporate tax revenues are 2.1 percent of gross domestic product (GDP) today, which is a bit higher than in the mid-1980s when the rate was more than twice as high.

Let’s compare to the United States. While Canada’s 15 percent federal corporate tax will raise 2.1 percent of GDP this year, the 35 percent U.S. federal corporate tax will raise just 1.7 percent. Thus, the Canadian corporate tax raises relatively more than the U.S. tax—even though the rate is less than half the U.S rate.

Canada historic tax revenues here. New Canadian budget data here.

My crusade against the border-adjustable tax (BAT) continues.

In a column co-authored with Veronique de Rugy of Mercatus, I explain in today’s Wall Street Journal why Republicans should drop this prospective source of new tax revenue.

…this should be an opportune time for major tax cuts to boost American growth and competitiveness. But much of the reform energy is being dissipated in a counterproductive fight over the “border adjustment” tax proposed by House Republicans. …Republican tax plans normally receive overwhelming support from the business community. But the border-adjustment tax has created deep divisions. Proponents claim border adjustability is not protectionist because it would automatically push up the value of the dollar, neutralizing the effect on trade. Importers don’t have much faith in this theory and oppose the GOP plan.

Much of the column is designed to debunk the absurd notion that a BAT is needed to offset some mythical advantage that other nations supposedly enjoy because of their value-added taxes.

Here’s what supporters claim.

Proponents of the border-adjustment tax also are using a dodgy sales pitch, saying that their plan will get rid of a “Made in America Tax.” The claim is that VATs give foreign companies an advantage. Say a German company exports a product to the U.S. It doesn’t pay the American corporate income tax, and it receives a rebate on its German VAT payments. But an American company exporting to Germany has to pay both—it’s subject to the U.S. corporate income tax and then pays the German VAT on the product when it is sold.

Sounds persuasive, at least until you look at both sides of the equation.

When the German company sells to customers in the U.S., it is subject to the German corporate income tax. The competing American firm selling domestically pays the U.S. corporate income tax. Neither is hit with a VAT. In other words, a level playing field.

Here’s a visual depiction of how the current system works. I include the possibility that that German products sold in America may also get hit by the US corporate income tax (if the German company have a US subsidiary, for instance). What’s most important, though, is that neither American-produced goods and services nor German-produced goods and services are hit by a VAT.

Now let’s consider the flip side.

What if an American company sells to a customer in Germany? The U.S. government imposes the corporate income tax and the German government imposes a VAT. But guess what? The German competitor selling domestically is hit by the German corporate income tax and the German VAT. That’s another level playing field. This explains why economists, on the right and left, repeatedly have debunked the idea that countries use VATs to boost their exports.

Here’s the German version of the map. Once again, I note that it’s possible–depending on the structure of the US company–for American products to get hit by the German corporate income tax. But the key point of the map is to show that American-produced goods and services and German-produced goods and services are subject to the VAT.

By the way, it’s entirely possible that an American company in Germany or a German company in America may pay higher or lower taxes depending on whether there are special penalties or preferences. Those companies may also pay more or less depending on the cleverness of their tax lawyers and tax accountants.

But one thing can be said with total certainty: The absence of an American VAT does not result in a “Made-in-America” tax on American companies. Even Paul Krugman agrees that VATs don’t distort trade.

Moreover, Veronique and I point out that the lack of a VAT creates a big advantage for the United States.

One big plus for Americans is that Washington does not impose a VAT, which would enable government to grow. This is a major reason that the U.S. economy is more vibrant than Europe’s. In Germany, the VAT raises so much tax revenue that the government consumes 44% of gross domestic product—compared with 38% in America.

And to the extent that there is a disadvantage, it’s not because of some sneaky maneuver by foreign governments. It’s because of a self-inflicted wound.

America’s top corporate income tax of 35% is the highest in the developed world. If state corporate income taxes are added, the figure hits nearly 40%, according to the Congressional Budget Office. That compares very unfavorably with other nations. Europe’s average top corporate rate is less than 19%, and the global average is less than 23%… That’s the real “Made in America Tax,” and it’s our own fault.

The column does acknowledge that BAT supporters have their hearts in the right place. They are proposing that new source of revenue to help finance a lower corporate tax rate, as well as expensing.

But there’s a much better way to enable those pro-growth reforms.

If Congress simply limits the growth of outlays to about 2% a year, that would create enough fiscal space to balance the budget over 10 years and adopt a $3 trillion tax cut. If Republicans want a win-win, dropping the border-adjustment tax is the way to get one.

And what if Republicans aren’t willing to restrain spending? Then maybe the sensible approach is to simply cut the corporate tax rate and declare victory.