There is no disagreement that changes to the tax code should promote economic growth, fuel job creation and increase incomes. The question is whether the Republican tax bills would accomplish those goals.
Several prominent conservative economists have argued that the proposals would do just that.
Many others across the ideological spectrum have challenged those conclusions, saying the plan would cause the nation’s debt to rise substantially faster than the economy. Deficit-financed tax cuts are widely believed to undermine growth.
There is also substantial disagreement about who would ultimately gain. Republican leaders argue that the substantial tax cuts for business would eventually result in wage increases. Critics counter that there is little historical evidence for that claim.
The New York Times invited two economists to offer their views in an email exchange on the plan’s economic merits and drawbacks. They are Douglas Holtz-Eakin, a former director of the Congressional Budget Office and the president of the conservative American Action Forum, and Kimberly A. Clausing, an economist and tax expert who teaches at Reed College. Their responses were condensed and edited.
How will these tax proposals affect the economy?
The economic logic is straightforward and time tested. Better incentives — like lower tax rates, being able to write off investments, taxation only on earnings in the United States — will encourage innovation, investment, hiring and pay raises. These incentives increase the accumulation of capital, whether in physical equipment or intellectual know-how.
This capital deepening — having more and better capital for each worker — reverses recent trends and raises productivity growth. More rapid productivity growth, in turn, raises the real wages of the middle class and restores upward mobility to a stagnant labor market.
Kimberly A. Clausing
There is nothing wrong with the idea that reducing a tax on capital will spur investment, which should increase worker productivity and, eventually, wages. But these models ignore important features of the real world, the tax code and the proposed tax law changes.
First, the current tax system already encourages debt-financed investment, but that incentive actually diminishes under the proposed changes. Second, we are already living in a world awash in capital; a shortage of capital supply is not the problem holding back investment.
Companies have historically high levels of after-tax profits. Why do we think giving an even larger windfall to shareholders will suddenly fuel investment?
For companies to seek new investment, they need a healthy middle class. Perhaps that is why so few C.E.O. hands went up at a recent event when asked if they would use tax cuts to increase investment; few companies plan new investments in response.
What will be the impact on the deficit?
The bills’ backers conveniently assume away the deficits that finance these tax cuts; such deficits are likely to either raise interest rates or increase borrowing from foreigners (such that more of the country’s income flows abroad in the future), or do both. Even estimates accounting for growth effects, by nonpartisan entities such as the Joint Committee on Taxation and the Tax Policy Center, find that the bills increase deficits by $1 trillion to $1.25 trillion over 10 years. Those factors will be a drag on the growth of American living standards.
While the backers of the bill emphasize its supply-side benefits, the growth effects of these tax bills are being vastly oversold. Future taxpayers will be left with both increased income inequality and higher debt burdens. By 2027, the Joint Committee on Taxation estimates, 84 percent of households will face either a tax increase or a tax cut that is smaller than $100. This will be small consolation for the future taxes needed to pay off debt.
A fair concern has been raised over the need for additional federal borrowing as a result of the proposed reform. Certainly the level and trajectory of the federal debt are a troubling issue, and a revenue-neutral approach would have been preferable. But it is important to get the right order of magnitude of any impact.
Of the additional $1.5 trillion of additional deficits permitted by the reconciliation rules, roughly $500 billion will occur in any event, either as part of the reform or when expiring tax provisions get extended. Of the remaining $1 trillion, somewhere between $400 billion and $600 billion will be offset by additional growth.
That means the Treasury will need to finance another $40 billion to $60 billion more each year. This is a drop in the bucket of the Treasury market, with inconsequential implications for the overall level of interest rates.
Is it worth a tax break to bring home profits booked overseas?
American businesses have booked roughly $3 trillion overseas to avoid paying United States taxes. Under the Republican plan, they would get a tax break worth about $500 billion in return for bringing the money home. Republicans argue that the money would be used to create jobs. Critics say the proposal would reward companies for tax-avoidance strategies without — based on past cases — an economic dividend.
The bill would stipulate that on a certain date every dollar of overseas earnings will be deemed to have been repatriated and corporations will owe their respective tax. At that point, firms face the real economic choice — bring the money back or not — not influenced by taxes. This is very different from past repatriation holidays and should be expected to have much better results. The same pro-growth incentives that influence domestic investors will apply to the overseas earnings.
There is simply no economic rationale for a windfall to shareholders based on their prior tax avoidance, and there is no economic evidence that such windfalls promote United States investment or job creation.
Can Americans expect to see benefits in their paychecks?
Faster productivity growth will translate into more compensation — wages and benefits — for workers. This is a tight historical relationship that has somehow recently become controversial, but there is research that debunks claims to the contrary.
These tax cuts are unlikely to spur large increases in wages; careful cross-country evidence fails to find benefits to wages from corporate tax cuts. If we truly wanted to help the middle class, we would focus on its needs directly, by providing it with the lion’s share of any net tax cuts, and by ensuring that the government has the revenue needed for important infrastructure, education and health care needs as well as the flexibility to respond to the next recession.
This bill has been promoted as a boon for the middle class. Does it fulfill that promise?
Capital accumulation, productivity growth and living better: That is the case for tax reform. It would be an easier political sale if there were a straight line from the policy to the prosperity (which is why the left prefers programs that write checks). But the logic is sound, the evidence conclusive and the case for tax reform helping the middle class impeccable.
This tax bill is not about workers. It is about giving shareholders and businesses lower taxes and merely hoping benefits will trickle down. Instead, give workers any tax cuts, and rely on the strength of the middle class to bubble up, strengthening American business. Sound tax reform should not lose revenue, and it should not give the vast majority of benefits to those at the top.