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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?
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. Below is an abbreviated transcript of our conversation. You can read our full discussion here. You can also subscribe to my podcast on iTunes or Stitcher, or download the podcast on Ricochet.
Pethokoukis: Should a modern tax plan mainly be focused on efficiently raising the overall revenue? If so, what changes would help to make that happen?
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. Those two things should be balanced in the pursuit of greater revenue — and we will definitely need that revenue where it can be found. With the growth of Social Security, Medicare, Medicaid, and health insurance premium credit spending, revenue-raising plans will be necessary. 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.
There are a couple of different options that meet the standards for both revenue efficiency and fairness. So, 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.
In order to get a VAT, you would need bipartisan agreement. 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. 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.
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.
Will the effects of the 2017 tax cuts ever actually be settled? There is very little consensus about what larger economic changes can actually be attributed to them, so will this just be something that scholars like yourself are going to have to work out in a decade when the cuts are a little farther removed from politics?
It might not become part of my work personally, but certainly for the public finance economist profession as a whole. 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.
Viewing every economic policy through the lens of the tax cuts is always a problem, of course. You can never definitively say with absolute certainty what the effects were, for the same reason that we can never say what would have happened if the tax cut had never been adopted. 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?
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.
However, 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.
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. 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.
Is there any sign that proposed tax policies from the Democrats would have a clearer balance of fairness and revenue-generation? They seem relatively revenue-apathetic, but they have adjacent goals like economic growth.
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.
However, while the Democrats signal their disagreement with Republicans by forwarding these proposals, I don’t actually think the Democrats will raise the corporate tax rate back up to 35 percent. 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.
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.
Even though it would likely have to be through executive order, one proposition for revenue-generation on the right is indexing the capital gains tax. The administration likes the idea, and I’m wondering if there’s a strong economic argument for it.
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. 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.
But the economic rationale for it is to increase investment. It presumably would work, 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 earn four percent interest (not that anybody can really do that these days) and inflation is two 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.
I would say this though. 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.
What does it look like the next big tax policy might be, given where the Republican and Democratic Party priorities now lie?
I’m not sure the Republicans really have any tax ideas now. 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 by that time. 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 around then. The limit on how much interest businesses can deduct is scheduled to become significantly tighter around then. And research and development spending which is expensed today ironically is scheduled to lose that status – you have to write it off over a five-year period starting in 2022, so the opposite of what they did for equipment. And so, I don’t know whether Republicans really want those provisions to take effect or not. They wrote them into the law in 2017. It limited the revenue loss from the tax cut, but I think a lot of people expect that as that time approaches the businesses that are affected will start to lobby Congress to do away with those increases before they happen. And so that’s something that Republicans would need to address if they were in power.
I also have not seen a big push for the classic, old-fashioned tax cuts by the Republicans. They might be willing to support them if they were proposed. Some of the Democratic candidates are talking about middle-class tax cuts, with Senator Kamala Harris as the prime example. She has a big middle class tax cut that can be viewed as a really dramatic expansion of the EITC. So if she were to take office or if another Democrat were to take office and put a middle class tax cut of that type forward, there might well be Republican interest in agreeing to that.
Now people would disagree as to whether that’s a better or worse tax cut than the 2017 tax cut. They would both have one thing in common, of course, which is that they add to the deficit and make the fiscal imbalance bigger.
AEI’s Alan Viard discusses the conversation surrounding the effects of the 2017 tax cuts and the future of tax policy in America.
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