Midterm issues: Taxes (E - 64)
09/03/18 Filed in: Taxes | Budget
Reader feedback at end
The tax cut bill enacted last December represents the primary accomplishment of Congress in the current session – and it was passed (using the reconciliation process) without a single Democratic vote. Unlike most of the issues that may come up on the congressional campaign trail this fall, therefore, the focus will be on accomplishments versus promises. Part A.
Republicans will assert that the tax cut has been a boon to the economy and they may talk about further legislation to make it even better. Democrats are unlikely to advocate repeal of part or all of the tax cut since calls to “raise taxes” don’t typically resonate with the electorate, but they will belittle its purported benefits and question its sustainability. Part B.
As matters stand, the tax cuts represent a modest net plus for Republicans, but no more – and the further steps under discussion aren’t likely to aid their cause in November. Part C.
To win the tax policy argument longer term, conservatives will need to rethink the purpose of the tax system and support fundamental policy changes. Failing this, the outlook is for a progressive balkanization of the government’s fiscal affairs. Part D.
A. Background - Shortly before Christmas last year, the president signed the Tax Cuts and Jobs Act into law. There was much jubilation among Republicans about delivering what was described as a $1.4 trillion tax cut (over 10 years) and “the biggest tax reform bill in a generation.” House Speaker Paul Ryan surely realized how inapt a comparison to the Tax Reform Act of 1986 was, more on that later, but he used it anyway. President Trump signs Tax Cuts and Jobs Act into law, signaling promise kept to the American people, Ali Meyer, freebeacon.com, 12/22/17.
Despite projections that the tax cut would increase the deficit and the modest amount of real tax reform that was involved, SAFE supported this proposal as a means of boosting economic growth. Year-end frenzy in DC, tax reform, 12/11/17.
The Republican tax plan doesn’t go far enough in eliminating tax preferences for either individuals (increasing the Child Tax Credit would represent a step in the wrong direction) or businesses. And although the tax cuts should fuel faster economic growth, thereby reducing revenue losses, projected deficits would still be boosted by some $1 trillion over the next decade. Nevertheless, we believe enactment of the tax plan would represent a solid achievement.
SAFE envisioned that the tax cuts might be accompanied by spending discipline, which in combination could set the stage for overall deficit reduction. Our hopes were dashed, however, by the Bipartisan Budget Act enacted in February. Not only did the BPBA clear the way for a 2-year, across the board spending increase of up to $432 billion, but it also reversed numerous tax reforms that had seemingly been accepted earlier. More shutdown drama, mediocre results, 2/12/18.
In hindsight, we underestimated the influence of corporate lobbyists. With no explanation or apparent justification, dozens of expired or expiring tax preferences were “extended” by the BPBA.
SAFE’s dissatisfaction with the BPBA and path forward suggestions were communicated in personalized notes to the president and his budget director, the top leaders of Congress (Ryan – Pelosi – McConnell – Schumer), House Ways and Means Chairman Kevin Brady (in Brady’s case, focusing on the sneaky restoration of special interest tax breaks), and others. SAFE to DC: Please fix this problem, 2/26/18. Sad to say, none of the addressees acknowledged our comments let alone taking corrective action. [Update: The president did subsequently respond to our letter, and his response has been duly posted. We never did hear from any members of Congress.]
B. Dueling assessments – Republicans point to generally upbeat economic results (e.g., annualized GDP growth of 4.2% in the 2nd quarter of 2018) as evidence that (1) the tax cuts (which will impact tax returns filed in 2019 and are already affecting tax withholding & estimated tax payments) and (2) regulatory cutbacks are working as promised. Trump says strong economic growth proves “historic” turnaround, Dave Boyer, Washington Times, 7/27/18.
•“We’re on track to hit the highest average annual growth rate in over 13 years,” Mr. Trump said at the White House. “We’ve turned it all around.”
•House Ways and Means Committee Chairman Kevin Brady, Texas Republican, said “our economy is booming,” and he credited “a competitive tax code, bold reforms to regulations, and encouraging news this week on trade.”
•Chad Moutray, chief economist for the National Association of Manufacturers: "Over the last six months, tax reform and regulatory relief have sparked the robust manufacturing job growth we predicted, improving lives and livelihoods across the country,” he said. “The business optimism of our member companies stands at a record high, and 86 percent of them plan to invest in new plants and equipment, 77 percent plan to increase hiring, and 72 percent plan to increase wages and benefits for workers."
For their part, Democrats have characterized the tax cuts as a boon to the wealthy, inconsequential for most Americans, and economically dubious. Consider these comments:
•Senate Minority Leader Chuck Schumer: Here are two headlines from today’s papers: First, the Associated Press: “Despite strong economy, many Americans struggling to get by." Second, from Bloomberg: “Why Americans Are Making Less Money Despite Trump’s Promises.” These two articles tell a story that the Trump administration and Republicans here in Congress don’t want you to hear: That their tax law is mainly benefitting the wealthiest Americans and biggest corporations while middle-class families are largely left in the dust. Facebook, 8/28/18.
•House Minority Leader Nancy Pelosi: We’ve seen this scam before. Republicans make a bunch of empty promises to the middle class and then write a bill that ultimately hands 83 percent of the tax cuts to the wealthiest 1 percent. Republicans want to explode the deficit with even more unpaid-for tax breaks for the wealthiest, so they can force devastating cuts to Medicare, Medicaid and Social Security. Families are drowning beneath stagnant wages, higher health premiums and soaring prescription drug prices, but the GOP continues to prioritize their tax breaks for Wall Street, Big Pharma, and corporations shipping American jobs overseas. Press release, 7/24/18.
The “nonpartisan” Congressional Budget Office views the economic pickup as temporary. Longer term, it’s suggested, the tax cuts will exacerbate projected deficits rather than setting the stage for reducing them. CBO: Tax cuts eating into feds’ bottom line as deficits rise, Stephen Dinan, Washington Times, 8/10/18.
New numbers released Friday by the Treasury Department show the government ran a $77 billion deficit in July, up 75 percent from the same month in 2017. Revenue dropped, while outlays rose, signaling danger signs on both sides of the ledger. The Congressional Budget Office said the dip in revenue is “in keeping with changes made by P.L. 115-97” — the tax cut overhaul Republicans powered through Washington late last year, cutting personal and corporate income taxes. *** [One] major danger sign is the growth of interest payments, which could quickly eat up any additional money that does come from the expansion. Indeed, the CBO said this week that interest payments leapt $10 billion in July.
But couldn’t the real problem be nonstop spending growth versus reduced tax revenues? Also, receipts were up by $26 billion for fiscal year 2018 vs. 2017 on a year-to-date basis. Tax revenues are higher, Wall Street Journal, 8/10/18.
Corporate income taxes were down substantially as expected in the wake of the tax reform that cut the corporate rate and added 100% expensing. But individual income taxes increased by $104 billion, or 7.9%, despite the cut in individual tax rates. How could that be? CBO says one reason is that withholding from paychecks increased by $32 billion, which “largely reflects increases in wages and salaries.” In other words, a faster-growing economy employed more people who made more money.
Future economic results are inherently uncertain, and it remains to be seen whether GDP growth will live up to the president’s expectations. If the economy overheated and produced an inflationary spike, for example, the Federal Reserve might be forced to slam on the monetary brakes. Or the president’s America First trade policies could backfire if his “hardball” tactics are carried too far, thereby disrupting global trade patterns and throwing the US economy into a tailspin. But for now, we think Republicans have some solid arguments that the tax cuts are paying off.
The GOP arguments won’t have much impact unless the general public is receptive, however, which may not be the case.
First, most Americans will evaluate the tax cuts based the effect on their own tax payments – never mind the beneficial effects of lower business taxes, which Democrats have slammed as a giveaway.
Second, there are a lot of ins and outs involved – big boost in standard tax deductions, largely offsetting elimination of personal exemptions, revised tax tables, changing rules for various tax deductions and credits. Many Americans won’t be clear whether they got a tax cut or not until they file their tax returns for 2018, and in most cases the cuts won’t be big enough to represent a real game changer.
Third, the tax cut bill was enacted nearly a year ago, so most people are fuzzy on the details, and the political conversation about the matter has further muddied the waters. Polling suggests that the tax cuts never had majority support in this country, and their popularity has eroded. Why the 2017 tax cuts are an election-year bust, Howard Gleckman, forbes.com, 8/29/18.
[Public] support for the [Tax Cut and Jobs Act] has slipped back to roughly 30%. While the partisan gap remains wide (about 70% of Republicans support the new law compared to one-in-ten Democrats), even GOP backing seems to have plateaued.
In short, Republicans don’t appear poised to reap the electoral benefits from the tax cuts that they were hoping for. Hence the thought that further action might serve to revive the excitement about tax cuts and promote the GOP cause.
C. Tax Cut 2.0 – On July 24, Rep. Kevin Brady announced a framework for “Tax Reform 2.0.” The main element was a proposal to make the individual tax cuts that had previously been enacted permanent instead of allowing them to expire as of the end of 2025.
This would counter a Democratic talking point that Republicans have favored business and investor interests over the middle class, but it would also reduce currently projected tax revenues in 2026 et seq. while increasing projected deficits. Top GOP tax-writer unveils framework for second round of tax cuts, Joseph Lawler, Washington Examiner, 7/24/18.
Making the individual tax cuts permanent seems like a reasonable step as there was no good reason for letting them expire after 2025 in the first place. No one should mistake the fact, however, that the proposal belongs in the tax cut as opposed to tax reform category.
Rep. Nancy Pelosi slammed the proposal as a mere extension of the original legislation, labeling it “the GOP Tax Scam for the rich 2.0.” Press release, 7/24/18.
An astute fiscal conservative offered a more balanced view, namely tax rate cuts are a good thing but Americans shouldn’t expect a “free lunch.” Tax Reform 2.0? Let’s do better, Veronique de Rugy, townhall.com, 8/2/18.
Some of these tax reductions could be "paid for" by getting rid of tax carve-outs and other expenditures, which often distort how Americans spend money and benefit some of us far more than others. However, without serious spending restraint, any further tax reform -- even pro-growth reform -- is unsustainable in the long run.
Amen to that! Also, there’s no way the tax cut 2.0 proposal will be enacted before the elections. Even if implementing legislation passes in the House, so Republican candidates can say they voted aye, it will die in the Senate. It seems doubtful that voters would be impressed by such a maneuver.
Another idea would be to index capital gains for inflation, which could be supported as reform in that it would avoid the taxation of illusory profits. Rep. Brady has indicated that he doesn’t plan to reflect this proposal in the House bill, but the Treasury Department could arguably change the capital gain rules without seeking congressional approval. Trump says he’s thinking about indexing capital gains to inflation, John Micklethwaite et al., bloomberg.com, 8/30/18.
Politically, the indexation proposal would seem to play into the Democrats’ hands in that it would primarily benefit wealthy taxpayers. Also, the idea of adopting such a rule administratively was considered and rejected during the Bush 43 administration. Ibid.
More than 63 percent of the benefit would go to the top 0.1 percent of taxpayers -- and the tab would be $102 billion over the next decade, according to estimates by the Penn Wharton Budget Model.
D. Path forward – SAFE has traditionally favored revenue neutral tax reform in which revenue raised by eliminating tax preferences is used to pay for tax rate cuts. See, e.g., Five don’t dos for tax reform, 4/20/15.
It may be too late for such an approach now, however, as Republicans have already cut tax rates about as much as will be possible – given current fiscal realities – while skimping on real tax reform.
Eliminating tax preferences cold turkey is practically impossible, and major tax rate cuts were essential to the rare success that was achieved in 1986. This day in history: President Ronald Reagan signs the Tax Reform Act of 1986, Adam Rodman & Brendan Welsh, atr.org, 10/22/13.
Reduced top marginal individual income tax rate from 50% to 28% - cut top corporate income tax rate from 46% to 34% - reduced total number of income tax brackets from 14 to 2 – limited numerous tax preferences, e.g., eliminated individual tax deduction for credit card, etc. interest expense.
Regrettably, much of the progress made in 1986 was canceled out in later years and the tax code is now far longer and more complicated than it was then. Ibid.
Americans are once again calling for a simpler tax code, but Washington continues to ignore the issue. In fact, a recent study found the federal tax law now totals nearly 74,000 pages. The most recent estimate of the current paperwork burden now generated by the Treasury Department now totals 6.7 billion hours.
The federal tax laws could be vastly simplified – with resultant economic benefits – if lawmakers were willing to slash the host of tax preferences that have been created over the years.
Ideally, the goal of the tax system should be to collect the required amount of revenue as efficiently and fairly as possible – not to micromanage the economy, promote designated social goals, or deliver benefits to this, that or the other segment of the population. As an example, consider the SimpleTax proposal that SAFE offered in 2010. Many details are out of date, but the perceived opportunity remains available – if policy makers would only embrace it.
SAFE’s approach to tax reform may never be tried; our role is to advocate sound policies and hope decision-makers will implement them. It may clarify the thinking of all concerned, however, to ponder the potential consequences of taking a different path.
Over time, as the government’s fiscal problem grows, disagreements about what to do about it will become increasingly heated.
The first response has been to ramp up borrowing, but if this pattern is continued the roof will cave in eventually – as all concerned realize at some level.
Spending cuts and/or tax increases of sufficient magnitude to solve the fiscal problem would be politically toxic, so the “grand bargain” that has been envisioned isn’t going to materialize. Don’t blame the leaders of either party, because the basic problem is a pampered population that has gotten hooked on the idea of getting “something for nothing.”
Another outcome could be intensifying efforts to balkanize the government’s fiscal equation, laying claim to portions of the available resources for designated purposes while leaving other government programs to shrivel and die. Some examples will serve to make the point, which might be summed up as “possession is nine tenths of the law.”
•Remember all those tax increases that were built into the Affordable Care Act in order to obfuscate the cost involved, with no apparent consideration that there might be higher priority uses for the proceeds? The dodge helped to get the ACA enacted, even though some of the taxes involved have since been abolished or delayed.
•A similar dynamic is inherent in tax levies that have been proposed to shore up other social programs. See, e.g., There’s a way to save Social Security, but it involves taxing the rich, Karl Polzer, Washington Examiner, 8/2/18.
No one knows when serious negotiations over Social Security’s future will begin. The longer Congress waits, the more difficult and painful the task. Americans need to know that Social Security’s solvency can be restored — with no benefit cuts [this is highly unlikely!] — by reclaiming and expanding contributions from high-income Americans. This position should be on the bargaining table in spite of cries of class unfairness and “soaking the rich.”
•Taxes have been proposed that would supposedly be acceptable to conservatives because the proceeds would be used to fight global warming, etc. Carbon tax: The push is on . . . and it’s coming from Republicans, Gregory Wrightstone, godfatherpolitics.com, 8/13/18.
The proposed [Market Choice Act] would impose a $23 per ton CO2 tax at the emission source including at the coal mine, refinery and gas processing site. Additionally, a yearly increase of 2% above inflation will be assessed, with no limits into the future. The bill seeks to replace the federal gas tax with the income dedicated primarily to the Highway Trust Fund (70%), plus block grants for cities and states for low income households (10%) and climate impact mitigation efforts (5%).
•Even traditional government spending programs may seek to get in on the action. Here’s an example that other hard-pressed administrators might find instructive. Hey, why shouldn’t the Interior Department grab oil and gas revenues to get national park maintenance back on track instead of allowing the proceeds to flow to the US Treasury for who knows what purposes? Top House Republican and Democrat reach deal to use energy revenue to fix national parks, Josh Siegel, Washington Examiner, 7/24/18.
#The taxes should be lowered once again and made permanent. - SAFE director
Comment: Running up the debt is a serious business, and the tax cut won't be offset by growth alone - as the piece by Veronique de Rugy points out. See also The Dangers of High Debt, rycK Stout, SAFE newsletter, Fall 2014.
#Great job, but I did have one question. With the millions of federal workers not getting their pay raise nor get any pay raise next year, what is that saying about the deficit caused by the new tax law? With prices going up, how is that a good thing? Just wondering what point I'm missing. - Retired financial manager
Comment: In our view, the deficits are primarily a function of unrestrained spending vs. the tax cuts. Also, government workers are overpaid (especially factoring in benefits) versus those with comparable jobs in the private sector, so why should they get automatic pay increases? That being said, it is something of a mystery why Trump chose to suddenly “get religion” about deficits without offering a broader-based solution. And he’s been getting lots of pushback from congressional Republicans on the pay freeze, so this “decision” may not stand.