Happy Returns

By Ramesh Ponnuru

Thursday, January 9, 2020

Like everything else in politics today, tax reform is polarizing. Two years after President Trump signed his biggest legislative accomplishment into law, the two camps that were arguing about it remain frozen in place. Supporters, including current and former administration officials, say that the tax law led to today’s turbocharged economy. Opponents say it was a deficit-busting giveaway to the rich that has done nothing for the economy. Some of these differences are matters of perspective that can’t be resolved by facts. But evidence is emerging on others.

The tax law of 2017 was the most far-reaching set of changes to the tax code enacted since 1986. Major changes to the tax law between those dates either cut taxes, as in 2001 and 2003, or raised them, as in 1990 and 1993. The new reform raised many taxes and cut many others in an attempt to improve the system. It was a net tax cut, but a complicated one that yielded higher taxes for some individuals and businesses.

The key provision in it that was supposed to promote economic growth was the reduction in the corporate-tax rate to 21 percent, an internationally competitive level. It was considered only fair to give “pass-through” businesses that file under the individual-income-tax code a tax cut, too, even though in general they pay lower tax rates than businesses that file under the corporate code.

The law changed the taxation of business in additional ways. It allowed companies to write off some investment expenses immediately instead of requiring them to do it over the life of the investment. (These provisions are set to fade away before disappearing altogether in 2027.) It changed the treatment of overseas profits in an attempt to reduce businesses’ incentive to invest abroad rather than at home.

The individual-tax code also saw sweeping changes. The standard deduction was increased, reducing the number of people with a reason to itemize deductions and thus reducing the importance of itemized deductions. The mortgage-interest deduction was itself pared back. The deduction for state and local taxes was capped at $10,000 per filer. Personal exemptions were abolished and the child credit was expanded, the net effect being tax relief for parents. Tax rates were reduced.

The extent to which the tax cut was tilted toward the rich, as Democrats say, depends on the answers to two questions. First, who pays the corporate tax? Economists used to think that owners of capital paid it, for example in the form of lower dividend payments. But that assumption has been called into question now that capital has become more able to cross national boundaries. Workers are less mobile. Economists agree that they pay some of the cost of the corporate tax, as reduced capital investment causes them to have lower wages.

The Tax Policy Center believes that wages bear 20 percent of the burden of the tax. The Congressional Budget Office puts the share at 25 percent. The results we have seen from the current tax law do not allow us to settle the question, but it is likely that workers have benefited from the reduction in corporate-tax rates.

Second, what counts as a fairly distributed tax cut? Republicans designed the tax law so that it would cut income-tax liabilities roughly in proportion to how much each income group paid. Thus the Joint Tax Committee, the agency of Congress used to make official calculations of the impact of tax policies, estimated that households making between $40,000 and $50,000 a year would see a 9.4 percent reduction in federal taxes, while households making between $200,000 and $500,000 would see a 9.0 percent reduction.

When Republicans say the tax cut was evenly distributed, that’s what they mean: Taxes fell proportionally to taxes paid, on average, and each group’s share of the federal tax burden stayed roughly the same. Progressive analysts of the law generally use different measures. They note, for example, that the law saved high earners many more dollars than low earners. That’s inevitably true of any proportional reduction in a progressive tax, since high earners pay many more dollars in taxes to begin with.

How much the tax law has expanded the economy is a murkier, and much-debated, question. Economic trends since it was enacted have been positive — but they had been positive for several years beforehand, too. Look at a chart of employment growth and you won’t see it bend upward or downward when the law was passed or took effect. The pace of economic growth in the six quarters after passage was roughly the same as in the six quarters before.

The tax law could have helped the economy in two ways. It could have stimulated the economy in the short run by expanding the deficit, and it could have strengthened it over the long run by improving incentives to work, save, and invest. Economists at Goldman Sachs estimate that the former accounted for more than half a point of GDP growth in 2018, but think the effect is over.

The case proponents made for the law depends on the latter effect. We have good reasons for expecting the law to benefit the economy over the long run, at least if it is maintained over the long run. But we should expect that beneficial effect to be modest.

The law reduced effective tax rates on investment in structures, equipment, and intellectual property, and the amount of such investment rose. But investment overall has not picked up.

The Congressional Budget Office estimated that national income will be 0.4 percent higher during the next decade than it would be without the tax law. What we have seen so far is consistent with that outcome.

A small effect should not be surprising. The government has many policies that affect the economy. In the time since Trump signed the tax law, he raised taxes on many imports, and the Federal Reserve first raised and then lowered interest rates. And of course it is not just government policy that determines the course of our large and complex economy.

The effect of the law on the deficit is easier to discern: It has increased it. Republicans obscure this point by saying that federal revenues are higher now than they were before the tax cut. But revenues rise in most years, because of inflation and economic growth. To figure out the impact of the tax law on the deficit, we would have to compare the revenue the federal government raised after it to what it would have raised if the law had stayed the same. We can’t know that counterfactual number with any certainty. But we know that revenues came in well below what the Congressional Budget Office had expected the federal government to raise under the earlier version of the tax code. When corrected for inflation, revenues actually fell from 2017 to 2018, even in a growing economy.

While they were trying to get the tax law passed, some Republicans said that it would pay for itself. It would lead to so much more economic growth that revenue would rise. There is no evidence, and every reason to doubt, that this scenario has come to pass or is likely to happen in the future.

The tax law, in short, cut taxes for most people and businesses while increasing the deficit. It is modestly helping the economy. This summary does not exhaust its consequences. One example: Limiting the deductibility of state and local taxes may, over time, cause states to be more restrained in spending money and raising taxes to pay for it; it may even spur some states to cut taxes themselves. Another: Charitable donations have fallen a bit, as one would expect given the reduced importance of the deduction for them.

When it comes to the main points of contention between Republicans and Democrats, though, the truth about the tax law of 2017 lies in the vast middle ground.