Grading the GOP Tax Bill

Well we have a tax bill, and it is even more unpopular than Obamacare was right after it was passed on a purely partisan vote (just as the tax bill was). Only time will truly tell us the impact of this legislation.

During the debate leading up to the passage of this bill I laid out eight principles upon which tax policy should be based. I detail the reasons for the principles in my pamphlet, A Summation of the Principles of Taxation. Let’s see how this new Tax Cuts and Jobs Act of 2017 compares to the principles I outlined.

1. Taxes should be used to pay for the operations of government. (Grade D-)

The Tax Cuts and Jobs Act clearly does not move us any closer to eliminating the deficit or reducing public debt (the name says it all). In fact it is projected to increase the deficit by $150 billion, a 37% increase in the deficit for 2018. It would be hyperbole to say that paying for the operations of the government were not a consideration of our legislators but it was clearly of secondary importance. The primary goal was to pump up the economy (which is actually chugging along quite nicely) in order to create jobs (see below). The second priority of the tax bill continues to be to manipulate the behavior or citizens in order to achieve government approved goals. Of course 60 percent of expenditures go to entitlements, which are not government operations but transfer payments. Constitutionally obligated government operations are being starved in order to fund these payments.

2. Incomprehensible tax rules undermine the people’s trust in government so tax policy should be made understandable to citizens (Grade C)

While numerous deductions have been eliminated, many have been retained. In addition, while the goal of the legislators to normalize the taxes on small business to rates more or less equivalent to big corporations, the new rules on “pass through” income are very complex and confusing (and this is before the IRS begins drafting the actual regulations).

3. It is not possible to create a tax system that will deemed to be “fair” (Grade C).

Republicans think the new tax bill is God’s gift while the Democrats think it is the worst tax bill ever. The bill got no Democratic votes. But it is impossible to create a “fair” tax code. Everyone’s opinion about how fair the tax bill is personal, not rational. Even people who pay no tax now think it is unfair because other people will pay less. But if Republicans give it an A+ and Democrats give it an F, then the average is C.

4. Payment of taxes is an obligation of citizenship so all citizens should pay some tax. (Grade D)

In the 2012 presidential campaign, Mitt Romney noted that 47% of the population pays no income taxes. This new tax bill will increase that percentage. By doubling the standard deduction Republicans claim that 70% of tax filers will be able to use a simple postcard. Well of course! If you are not paying any income tax filing your “taxes” is easy. But this exemption further attenuates the shared burdens of citizenship that bind this nation together.

5. Tax policy should not be used to manipulate people or organizations. Grade B-

The new tax code eliminates many deductions and replaces them with a larger standard deduction. This will help the poor and lower income tax filers who rarely itemize their taxes and disadvantage the wealthy and those that live in high tax states (mostly Democrats). But it still retains the mortgage interest deduction and hedge fund billionaires can continue with the carried interest deduction (although slightly modified). So the Republicans have come partway along the path to a principled tax policy but they still haven’t reached the Promised Land.

6. Cutting taxes is not an effective means of generating long-term economic growth. Grade D.

Politicians distort the original intent of Prof. Keynes. He stated in his theory that increased government spending during a recession would increase aggregate demand and spur an economic recovery even though this would cause an increase in public debt. But he would not have recommended goosing an economy chugging along at 3 percent growth and record low unemployment even though the Fed is tightening monetary policy by raising rates. Washington gets a D because they don’t understand how the economy works.

Some pundits may say that the economy is booming and the stock market is hitting record highs in anticipation of the Trump tax cuts. But any boost in economic growth is likely to have been driven by reduced regulation where the Trump administration has been very effective in unwinding the regulatory stranglehold of the Obama administration. Pundits get a D too.

7. Corporate taxes should be competitive with the tax systems of our major trade partners. Grade A-.

The GOP tax bill reduces the corporate tax rate from 35% to 21% which, combined with state taxes that our large trading partners do not have, put it in about the middle of the pack. High corporate tax rates combined with a global tax regime distorted the economic relationship with our trading partners to our great disadvantage. This distortion caused US corporations to not repatriate their foreign earnings resulting in a $3 trillion cash hoard overseas. This cash hoard could be invested in new overseas operations or lent to a US affiliate such that US profits were transferred overseas. Ultimately, some US corporations merged with foreign companies in low tax countries such as Ireland and transferred their legal domiciles (and headquarters staff) to the low tax countries. These so-called tax inversions were labeled unpatriotic and even traitorous but the true villain was not the corporations but the US tax code.

The new tax code changes all that. Democrats assert that the repatriated money will be squandered in stock buybacks and huge dividends instead of invested to create new jobs. But our Democratic friends forget how the free market system works. By putting this money into the hands of investors the capital will reallocated to other companies and projects better able to utilize the funds. And the new tax code lowers the overall cost of capital, which will help marginal projects become profitable. In the long run this will mean more domestic investment, increased GDP and more jobs (keeping in mind that the new plant and equipment will be high tech such that the impact on employment will be muted).

But they also put in a few clauses that mess up an otherwise good story such as the immediate write off of investment in capital equipment (not a bad idea buy why for only five years and for one asset class). That and a few others meant they only earned an A-.

8. Economic growth is stunted by uncertainty so tax policy should not change every year. Grade D.

The Republicans passed the new tax bill with only a simple majority and no bi-partisan support. In order to qualify for a simple majority vote the deficit impact of the bill could not exceed $1.5 trillion over ten years, according to Senate rules. To accomplish this the Republicans made the corporate tax cuts permanent and the personal cuts temporary. But the Republicans assure us that when the ten years are up, they will vote to extend them. But all this legerdemain is nonsense. No Congress can bind a future Congress from making new law. Only the Constitution can do that. So the Republicans end up just looking dumb.

When the Democrats regain control of congress (which they will eventually do) they can vote for a new completely different tax bill that they can pass on a partisan vote. And while the Republicans and Democrats tack back and forth on opposing tax policies our trading partners as well as economic rivals will be steaming right past us.

Conclusion. Grade C-

The new tax bill is neither as bad as Democrats assert nor as good as Republicans proclaim. It has some good ideas and some dopey ones. The biggest problem of this legislation is that it is not based on sound American principles but on political wrangling. The best thing I can say about the bill is that it replaces the old tax code that was Grade F. The only way to build bi-partisan support and a national consensus is to develop a tax policy consistent with America’s Founding Principles.