|
How have the Trump tax cuts affected America’s economy, or do we even know yet? Have they stimulated investment as promised? More broadly, what solutions are at our disposal to fix the deficits these cuts have generated? What are we to make of proposals to repeal the Cadillac tax or index the capital gains tax to inflation? And which tax policies will the left and the right pursue next? On this episode, twice-returning guest Alan Viard of AEI joins me to explore these questions.
Alan Viard is a resident scholar here at AEI, where he researches federal tax and budget policy. He earned his PhD in economics from Harvard University, has worked as a senior economist at the Federal Reserve Bank of Dallas, and was a senior economist at the White House’s Council of Economic Advisers.
PETHOKOUKIS: Alan Viard is a resident scholar here at the American Enterprise Institute, where he studies federal tax and budget policy. Previously, he was a senior economist at the Federal Reserve Bank of Dallas and an assistant professor of economics at Ohio State University. His work has been featured in a wide range of publications, including The New York Times, The Atlantic, and Bloomberg. He’s here today to discuss the future of tax reform. Alan, welcome to the podcast again.
Before we jump into tax reform, current tax issues, and the aftermath of the Trump tax cuts, I want to look ahead a little bit. I was thinking that if I was tasked with putting together a blue ribbon panel on taxes and come up with a tax reform plan that would serve America well over the next decade or two, the charge I would give them would be to come up with a plan that can raise more revenue than what we’re currently raising, but in the most economically efficient way possible. Is that the number one goal?
VIARD: That is the goal, yeah. There’s one other thing to go with that: along with raising the revenue efficiently, we also want to raise it fairly. But yes, I think you’ve really hit the main points there. We are going to need more revenue, given the growth of Social Security, Medicare, Medicaid, and health insurance premium credit spending. We know that the budget faces long-term imbalance. I hope, and many people hope, that there will be some restraint on that spending growth and that we can accomplish part of what we need to do on that side of the ledger. However, if you look realistically at the spending pressures that exist and the political support for those programs, we know that revenue increases will have to be part of the equation. So we are looking for more revenue, and we do want to try to raise it in the best way possible, balancing efficiency and fairness. Now, naturally, there’s a lot of disagreement as to what the best way to raise revenue is.
The idea that long term entitlements pose a real problem seems to have lost some support. There seems to be less concern about debt and deficits going forward, and therefore I would imagine people are less interested in coming up with a tax reform plan where at least one of the goals would be to raise more revenue as opposed to some other goal like economic growth. When you talk to other economists, is this revenue-apathy a growing voice in the discussion?
Well, I think economists still think largely what we’ve always thought, and economists still recognize the need for additional revenue. Now, on the political side, I think things have shifted in some ways. The Democratic presidential candidates are proposing policies that would significantly increase revenue – almost always, of course, by targeting those at the top of the income distribution.
Now, at first glance that might seem like good news on the fiscal front – someone is prepared to address things on one side of the ledger. But the problem is that while the candidates are proposing revenue increases, they’re also proposing very large spending increases, which would swamp any revenue effect.
I mean you look at things like Medicare-for-all, let alone the Green New Deal, and then a host of other programs such as student loan relief, or childcare subsidies, we just have a whole array of spending programs being presented. So any progress that made on the tax front would be far more than offset by the spending increases.
Have you heard of any new ways to raise tax revenue that sound like good ideas, that are done in a fair and efficient way?
Well, in the past I’ve tended to think that we ought to try to shift to an almost completely new tax system: the Bradford X-Tax, which is a novel method of taxing consumption. I still think that is an economically appealing way to raise revenue, but I’ve come to conclude that politically it’s not viable. People don’t understand it and won’t support it, so I find myself falling back on what is a very common idea, which is to introduce a value-added tax alongside the income tax. All other industrialized countries in the world use a value-added tax. It’s reasonably easy to administer, although of course, every tax has administrative problems.
It is somewhat regressive and poses somewhat larger burdens on low-income groups than on high income groups, but, as many governments around the world have discovered, there are easy ways to address that: you can give rebates at the low end or you could combine it with the income tax system scaling back the income tax to bring in the VAT alongside it and find a fair balance. At the moment, though, there is not much support for a value-added tax.
A VAT seems like a reasonable way of approaching sort of these long-term issues, but I think you’re right: it feels like it’s impossible for that to happen. What would it take for that change to occur?
One thing that would be necessary is a bipartisan agreement. Neither party will ever introduce a VAT on its own—you would have to have Republicans and Democrats coming together. For that to happen, you would have to have divided government. If only one party is in power in both chambers of Congress and in the White House, the other party’s not going to make a deal. But if you had a situation where the parties were sharing power and they were willing to work with each other and they recognized that the fiscal imbalance needed to be addressed, then it’s not too difficult to see them eventually accepting a VAT.
The way a compromise usually works is that neither side gets their first choice, but if it’s a good compromise, both sides get their second choice, and that’s what would happen here. Democrats would probably say, “well, ideally we would like to address the fiscal gap by raising more income tax revenue, but we definitely don’t want to do it by dramatically scaling back entitlement growth, so the VAT is an intermediate option that we can live with.” Then Republicans might, at least in principle, say “we would prefer to address the fiscal imbalance by restraining entitlement growth, but we definitely don’t want it to be addressed by raising income tax revenues.” So the VAT could be an intermediate option for them, too.
That’s the kind of arrangement you would see if and when such an agreement emerged: both sides settling for their second choice. I believe that will eventually happen. You may wonder when, and I wonder when as well. I don’t think we’ll see it in the next five years; I don’t think we’ll probably see it in the next ten years; but could we see it in the next 20 years or the next 30 years? I think yes, because at some point we’ll really run out of alternatives.
This assumes that modern monetary thinking is wrong, and the fact is that we can’t just keep borrowing indefinitely. There will be a market impact, an interest rate impact, or a currency impact where markets will bring this issue to the table and force politicians to do something.
Yeah, if nothing else happens, a crisis could be what ends up forcing the agreement.
Granted, a crisis may be quite some distance away yet. I think that it’s a mistake for some supporters of deficit reduction to claim that a crisis is about to happen, and that we’ve got to act now. We should act now, so what they’re calling for is right, but trying to encourage action by telling them the crisis is almost upon us is a case of crying wolf. What you want to tell them and what you hope people understand is that the crisis will eventually come, and the sooner we address it before it comes, the better. I know that message doesn’t always work; people don’t grasp that there’s a long range issue to be grappled with. But I still think that’s the kind of message that we have to convey, instead of trying to trick people into thinking that a crisis is at hand.
But if we do keep waiting and postponing and procrastinating, then eventually the crisis will hit us and we’ll have to address it, which won’t be the ideal way to do it.
What would that crisis look like?
Well, it probably involves something about foreign investors being unwilling to buy US Treasury securities to the extent that they have previously done. Interest rates on those securities would then spike.
It could also be triggered in part by a reduction in the amount of savings being done around the world, which would tend to reduce demand for Treasury securities. This might be exacerbated by doubt as to whether the Treasury will comply with actually pay all of its obligations. And this would be connected with a host of other negative economic events, like a falling stock market and so on.
Now let’s come back to the present. It seems to me that whenever an economic report comes out whether it’s a GDP report or one of many other economic reports, many times it gets viewed through the lens of the 2017 tax cuts. People will say “this data point shows the tax cuts are working” or “that data point shows that they’re not working.” What can you say with confidence about the tax cuts and their impact on the economy? What do we think we know at this point?
There’s always the problem, of course, that you can never definitively say with absolute certainty what the effects were, just for the well-known reason that we can never say what would have happened if the tax cut had never been adopted. You would have to compare the actual history we are living in, with the tax cut in place, to an alternative timeline where the tax cut never happened. So of course, outside of science fiction, we can’t really observe that alternative time. But what we try to do is make some educated guess about what we would have expected to happen in the absence of the tax cut, and then compare it to what we see with the tax cut.
I don’t think we can tell a whole lot yet, but maybe we can say a few things. First of all, it’s far too early to really say what the impact of the tax cut will be on wages, because the wage effects were never expected to show up in the short run, but instead expected to occur gradually over time as capital stock was built up through increased investment in the United States.
What we can be looking at now is whether that investment is happening, because that’s the first step in the process that leads to the wage growth. Here, the picture is somewhat unclear. One might well have thought that slashing the corporate tax rate from 35% to 21% (which is clearly a very big drop) and introducing immediate write-offs (“expensing”) for important types of business property would lead to a quick surge of investment in the United States. You never know how quickly these things will happen, but I would have expected that you would see reasonably dramatic effects reasonably quickly. I do think it’s fair to say that we are not seeing those effects as quickly as we might have hoped. Investment has been doing reasonably well since the tax cut was adopted. It’s been growing at a good pace. However, it was also growing at a good pace before the tax cut was adopted, and that’s not surprising because we’re amid a business cycle expansion.
So has the tax cut led to more investment happening than otherwise would have happened in the United States? My guess is it has, but it hasn’t been a big effect yet. That raises the biggest unanswered question at this juncture: should we conclude that the effects are going to be smaller than many economic models would have suggested? Or should we merely conclude that they are going to be slower than those models would have suggested? In other words, are the big effects still to come, or are they not going to happen? My own view is that, to some extent, I would still expect significant investment effects to happen. And yes, perhaps the timing is just a bit slower than we might have expected it to be, but we don’t know for sure, so we will have to wait and see.
We do know that taxes are only one factor among many that affect investment. The trade war could certainly be a confounding factor — the tax cut may well be boosting investment at the same time that the trade war is shrinking investment — we don’t know what would have happened in alternative timeline.
Would you expect that 10 years down the road there would be a consensus on whether they worked? Because it seems to me like we’re still fighting over the Reagan tax cuts and the Bush tax cuts. Will there be a consensus on these cuts at some point down the road?
There won’t be a consensus. There may be a narrowing of the range of disagreement, but even that won’t really happen by looking at the macroeconomic data.
I mean, yes, ten years from now someone can look at the path of investment over the last decade and that will certainly be time for the tax cuts to have done whatever they’re going to do, but how many other events would have happened in those ten years? How many new trade wars will there be, how many policy actions done by the Federal Reserve, how many regulatory changes?
The kind of evidence that may yield partial agreement is the microeconomic data. We know that the tax cut was more favorable towards some type of business property than others, so economists can and undoubtedly will do studies looking at how those different categories responded. That’s closer to a controlled experiment, because a lot of the general economic events that are going on at the same time would have affected all those types of property. Maybe not in absolutely equal ways, but it would have affected all of them, and if we can actually find patterns in different types of investment that line up with different degrees of relief given by the tax cut, then you would have a basis for concluding that the tax cut was actually causing some of the investment effects. On the other hand, if you did not find those effects lining up, that would be evidence against the tax cuts having an effect.
So where would you expect to really see an impact?
Well, equipment is expensed under the tax cut, which means that you can write off the full cost in the first year. That benefit was not given to structures. So you would look at equipment versus structures.
The corporate sector received a very large rate cut. Part of the non-corporate sector — businesses that are set up as partnerships and such – did get a tax write-off of their own, but it doesn’t apply to all sectors of the non-corporate economy. So once again, you could look to see if there’s a differential effect: if corporate investment went up by more than non-corporate investment. That’s the kind of thing people will be looking at.
It sounds like for the next 5-10 years, this is going to be a big part of your scholarly research.
Well, maybe not mine personally, but certainly for the public finance economist profession as a whole, yes. There are economists who are very sharp at doing that type of empirical work. It’s nitty-gritty work, but it’s very valuable. It takes time for the data necessary for those studies to become available, and then time for the studies to be done and go through the peer-review process, but eventually we’ll start to see some results of those investigations and we can reach some kind of verdict on the tax cut.
Now that there’s been some talk in these Democratic primaries as the candidates have released their plans. None of them likes these tax cuts. Some have talked about repealing them completely, which I guess means taking that corporate tax rate back up the 35%. What would the impact of that be?
Yeah, I don’t think the Democrats will do that and some of the rhetoric that some of the candidates have used is somewhat imprecise. It’s never clear – or it’s often not clear – whether they’re objecting to all of the 2017 tax cut or whether they’re merely saying that it needs to be repealed and replaced as opposed to just repealed. It’s hard to know in many cases.
I would be very surprised if a Democratic Congress and President took the corporate tax rate back above 28 percent. It will depend on who the Democratic president is and what the margins of control are in the chambers of Congress. And I guess it does look like the Democratic party is going further to the left now than you might have expected some time ago, but 35 percent was a very high rate by international standards. I mean, that’s putting it mildly – when you add the four percent average state corporate income tax, we were at 39 percent. That was the highest rate in the developed world, and the third highest in the entire world. To go back to that really does not make the United States very competitive.
So you often see proposals, at least among Democratic policy analysts, to go back to 25% or to 28 percent, perhaps accompanied by measures to make the corporate base broader. So the corporations are paying tax on more income, as well as at a somewhat higher rate than 21 percent but not going all the way back to 35 percent.
I know in the past you have pitched the idea of lowering the corporate tax rate further, but then offsetting that with a higher capital gains tax rate. When you talk to people, is there any interest in that idea? It seems really to make a lot of sense.
It seems like a very good trade off to most economists. The taxing of capital gains and dividends of American shareholders is less economically harmful than taxing investment done inside the United States — the difference between the two taxes being that the tax on the dividends and capital gains doesn’t depend upon where the corporation invests its funds. With a higher capital gains tax, you’d be taxing the American shareholders of those companies regardless of where the investment happened, so it would not drive capital out of the United States and it would not drive down wages. It also would not encourage so-called inversions or efforts to do profit-shifting where you book profits into tax havens. So a lot of those harmful consequences don’t arise if you’re taxing the dividends and capital gains instead of the corporate profits. On the other hand, you might discourage saving by Americans if they’re paying more taxes on dividends and capital gains. So obviously there’s always some issue with any tax.
How much interest is there in it? It’s not clear politically that the idea has gotten much attention. Some of the Democratic candidates are certainly talking about raising capital gains and dividend taxes. But of course, they’re also talking about raising the corporate tax – at least relative to the 21 percent. So the idea of that trade-off doesn’t seem to have taken hold.
One of the interesting parts of the of Trump tax cuts was the cap on the state and local tax deduction, which is more of a tax on wealthier Americans. But there seems to be an interest among people who you would be for that sort of tax in reversing that cap.
Yeah. It’s really drawn strong opposition from a lot of Democrats. It does kind of scramble things up politically because at least the direct tax increases resulting from that change do fall on higher income people. And so you would think that the Democrats would not be as concerned about those groups as they would be about groups further down the income scale.
Now, I think the Democrats would have a counter argument to that. They would say that having this cap in place makes it more expensive for state and local government to raise their taxes and increase their spending programs, because the people who are paying those taxes don’t get as much tax relief at the federal level.
And indeed, that’s what Republicans hoped would happen.
Oh, that’s right. It was a very conscious goal by the Republicans. They believed that the old arrangement where you had an uncapped deduction artificially encouraged the growth of state and local government. So in some sense, they were trying to change that. That’s what the Democrats do not want to see. They would argue, “Well, the cap indirectly will hurt lower income people because state and local governments will end up doing less spending on their behalf, because they’ll have less tax revenue, because they won’t be able to get support raising taxes, because the people were paying the taxes won’t get a federal deduction on the margin.”
It really has had a significant impact in the high tax states, like California, Connecticut, New York, New Jersey, and Maryland. And those states are fighting to try to either get around the cap or to try to have it repealed by Congress – or at least not extended when it expires at the end of 2025. They even filed a lawsuit arguing that the cap is unconstitutional, which is a legal argument that I think has no merit at all.
But as an economist, do you do like this cap?
I think the cap does make sense. This actually is a tricky issue. Anybody who says there’s a simple way to think about it is probably mistaken. But I don’t think that there is a strong argument that the federal government, by providing a state and local tax deduction, should try to subsidize the growth of state and local government over and above the subsidies that the federal government already provides to numerous state and local government programs through specific grants.
So, for example, the Congress decided that Medicaid should be administered at the state level and that it’s desirable to have Medicaid be bigger than any given state would choose if they were picking up the full tab (and I think Congress is right to think that). Therefore, as states spend money on Medicaid, the federal government pays a significant portion of the cost – anywhere from 50 percent to almost 80 percent. There, Congress has picked out a specific program and said, “We want to encourage its growth.” Once you’ve done that for numerous different state programs that you think are deserving, does it really make sense to have an additional subsidy that has state and local governments raise more money and spend it on any programs that they wish? It’s not clear why the federal government should encourage that.
Another tax issue which is a live issue is the Cadillac health insurance tax, which is a 40 percent tax on high cost employer health plans. Also not a particularly popular tax. There’s an effort in Congress to get rid of it. But economists like this tax even as politicians don’t.
Yeah, Politico recently commented that economists seem to be the only constituency that supports the tax, and since economists comprise a pretty small proportion of the American population that doesn’t bode well for the tax’s political future.
But there’s not much that there’s not much in the tax code that restrains cost. This is essentially the one thing that does that.
Yeah, so we start from an income and payroll tax system where you pay tax on the cash wages that your employer gives you, but you don’t pay tax on a lot of fringe benefits – including health insurance. So that clearly encourages health insurance over cash wages.
Now, you may say well that sounds like a good idea because helps more people get insured. Well, yes, if that’s all it was doing, then it would arguably be a good thing. But if you just wanted that, you would put some kind of cap on the amount of health insurance that would that people could get this tax break for. You wouldn’t give it to the high-end “Cadillac plans,” which cover routine care and encourage people to utilize a lot of medical care and therefore drive up costs for everyone.
So the most direct solution to this would be to change the income and payroll tax rules to say that if the health insurance is high cost, you would have the employees pay individual income and payroll taxes on the excess insurance. The Cadillac tax is a somewhat clumsy substitute for that. The tax is officially collected from the insurance companies, which is an effort to hide the fact that the burden ultimately falls on the workers getting the health insurance. And so it’d be better if you collected it directly from the workers to be more honest, and having this 40 percent flat rate doesn’t really make that much sense either.
But nevertheless, the basic purpose of the Cadillac tax is sound. It’s a way to offset or cancel out that tax break for the high-end plans. And so it’s really a desirable step compared to doing nothing. If you had a better designed replacement, fine, but it’s good as far as it goes.
Unfortunately, both Republicans and Democrats have lined up against the tax. Now there was a new letter – similar to one distributed four years ago – signed by approximately a hundred economists, myself and seven other residents at AEI among them. And we argued that the Cadillac tax should be kept until and unless it’s replaced by a better designed measure. But once again, it’s falling on deaf ears. The tax has not yet taken effect — it’s been postponed twice and is scheduled to take effect for year 2022. But just last month the House voted to repeal the tax before it takes effect, and that was a vote of 419 to 6. The Senate has not yet acted on the repeal bill, but there’s a good chance they will act on it this fall, and if they do act on it, I don’t think it’s too hard to guess which direction the vote is going to go, as more than 60 Senators have signed on as sponsors of a separate bill that would repeal the Cadillac tax.
Another big tax issue which is sort of brewing is indexing the capital gains tax which the administration wants to do, likely through executive order, since it couldn’t get through a divided congress. Is that legal to the best of your knowledge? And is there an economic argument for doing that?
Yeah, so the question of whether it’s legal is something legal scholars disagree about. I’m not a legal scholar, so I guess I shouldn’t weigh in definitively on it. When I read the articles on either side of that question, it certainly leaves me with grave doubts that the administration would have the legal authority. But there are some people who think that it does.
The issue is whether the administration can redefine the word “cost” as it’s used in the internal revenue code. When you sell an asset like a share of corporate stock, you pay tax on your sale proceeds, minus your cost. The idea is that you would take your initial cost – from back however many years ago you paid it – and adjust that upward to account for the inflation that’s occurred since then. So if you paid $10 to buy the stock years ago, but prices have doubled since then that was like paying $20 today, and economically it’s equivalent to having paid $20 today. And so the argument is that we’re going to count your cost as $20 dollars.
The legal question is this: when the Internal revenue code says “cost,” is that an ambiguous term that could mean inflation-adjusted cost and therefore the administration could interpret it to include inflation adjusted cost? Or does it unambiguously mean the cost expressed in dollars? Well, I think in context it sounds like the code refers to the cost expressed in dollars because that’s how everything else in the internal revenue code works. But legal scholars do disagree.
I would say this though. Even if this is within the outer limit to the administration’s authority, it would be wrong for the executive branch to make this kind of policy change without going to Congress for its approval. Congress through the years has refused to inflation-index the calculation of capital gains taxes. It has adopted other measures – like a lower capital gains rate – that are intended, at least in part, to compensate for the fact that there is no inflation adjustment. And so if the administration comes in and says by fiat that we’re going to do the inflation adjustment while still leaving in place the other measures that Congress adopted, they’ve really upset the kind of delicate compromise that Congress struck and put their own policy into place rather than the policy that the nation’s elected lawmakers have adopted.
So I think it would be undemocratic for the administration to do this on its own, even if it might buy some chance happen to be legal.
And would it be a good or bad economic idea if your goal is to increase investment, which I’m guessing would be the economic rationale?
That is the economic rationale, and it presumably would increase investment to some extent. But if the policy was enacted in the way that the supporters are talking about, it would also increase tax sheltering. Because it’s not just capital gains that aren’t adjusted for inflation. When you pay tax on interest income, you don’t account for the fact that some of that interest income offsets inflation as well. If I earned 4 percent interest (not that anybody can really do that these days) and inflation is 2 percent, then only two percent is real and gives me extra buying power. But we don’t adjust interest income and we don’t adjust interest expense when people take out business debt and deduct that interest.
So if you adjusted the capital gains but not the interest expense, it would become very profitable from a tax standpoint to borrow money and to invest in assets that yield capital gains. And so I think you’d see a lot of shuffling around of assets and paper transactions that would basically amount to tax shelters.
If inflation indexation makes any sense at all, two things should be done. First, it should be adopted by Congress in the way that the framers expected major tax policy changes to be made. Second, it should apply to interest income and interest expense as well as capital gains. So you can certainly make a case for that kind of policy, although, frankly, with today’s low inflation rates, I’m not sure it’s worth bothering with. Those kinds of inflation adjustments are actually pretty complicated – more complicated than you think when you start dealing with things like partnerships. And so at today’s low inflation rates, I’m just not sure that it’s all that attractive of a policy even if you met both of the conditions I just mentioned.
So to wrap up, given what we were just talking about – that it turns out that it’s really not so easy politically to raise taxes on people, what does the next sort of big tax reform look like when what either on the center right or center left? What are people talking about? What do you think happens next?
Well, I don’t think anything is going to happen before the next election. And then what happens after the election depends on who wins it. If the Democrats do take power in both chambers of Congress and the White House, I think you would expect them to move forward on some measure that would increase taxes on high-income people. I don’t know if you’d see something as unprecedented as Elizabeth Warren’s wealth tax. But you would probably see some increases in marginal individual income tax rates, some increase in the corporate income tax rate, and some increase in estate and gift taxes.
What’s the next big Republican proposal? Getting that corporate tax rate down from 35 to 21 – that accomplished a big Republican goal. So what next? You haven’t heard much about the flat tax lately. What’s the next sort of big idea?
I’m not sure the Republicans really have any. One focus that they will need to turn to I think is whether to extend the provisions of the 2017 tax cut that are scheduled to expire at the end of 2025. The corporate rate cut is permanent, but the individual provisions generally expire at the end of 2025. The special expensing for equipment that we talked about earlier phases out even earlier than 2025, and so that I think Republicans would want to extend that.
The Republicans also built in a surprising number of tax increases on the corporate side that are scheduled to take effect around 2022 or 2023. Three big provisions that affect multinationals are scheduled to become more severe aroun
How have the Trump tax cuts affected America’s economy, or do we even know yet? Have they stimulated investment as promised? More broadly, what solutions are at our disposal to fix the deficits these cuts have generated? What are we to make of proposals to repeal the Cadillac tax or index the capital gains tax […]
|
|
