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The Economics of the Trump Tax Reform Plan

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Firstly, it is imperative to understand the Trump tax reform. The reform cuts corporate tax rate from 35% to 21% and cuts pass-through business taxes by 20%. This lowers government revenue by approximately $1.5 trillion. Furthermore, there are also cuts to individual tax rates and a repeal of the “Children’s Health Insurance Program (CHIP)”. Economists have criticised the plan to repeal CHIP as it will cause 13 million less children insured over the next 10 years. And the insurance would only result in an $800 million expense per 5-year interval. This largely dwarfs the costs for the tax reform, which amounts to $1.5 trillion.

Economists have also condemned the tax cuts for favouring the wealthy, as the cuts for the top 10% income bracket are far higher than the cuts for the lower 90%. This is exemplified in the figure below.

However, economist Greg Mankiw, a professor at Harvard University, disagrees that the tax cuts are primarily for the rich, as he states: “True, that the top tax rate is reduced by 2.6% points. But for states with a personal income tax, this merely offsets the loss of the state and local tax deduction. And if you are in a high tax state like California, where the top tax rate is 13.3% the offset is far from complete.” He believes the central problem of the tax reform is a cut in the corporate tax rate, which will benefit shareholders, who are wealthier than the normal population. Economist Paul Krugman has a similar belief – he recently tweeted that in the US, the bottom 90% hold only 7% of stocks while the next 9% hold 40% and the top 1% hold 53% as shown in the figure below.

Despite this, Mankiw projects that in the long-term increased profitability should increase capital accumulation and productivity. Ultimately, workers will benefit from the corporate tax cuts. A recent publication by the Tax Policy Center which claims that 20% of the corporate tax cut will go to labor, further supports Mankiw’s projections.

However, recent news counters Mankiw’s projections. Over the last two months, since the bill was passed, only $6 billion has gone to workers through bonuses whereas $171 billion has been given to shareholders in the form of buybacks. Cisco and Pepsi are two prime examples of companies involved in the buyback spree. Wall Street favors buybacks, since it tends to increase profits per share reported, thereby increasing share prices.

Goldman Sachs CEO, Lloyd Blankflein, called the $100 - $1000 bonuses announced by companies to be symbolic - a mere act, not intended to create a long-lasting impact. Nevertheless, he adds that the symbolism matters because it will increase confidence in the economy which may initiate long-term investment.

The key aspect remains that bonuses and wage raises pale in comparison to the Wall Street buybacks. Similarly, a Morgan Stanley survey conducted at the beginning of February shows that only 13% of the company’s tax cut savings will go to pay raises, bonuses and employee benefits. Moreover, only 300 companies have announced tax-cut related bonuses & raises. According to the White House, this only benefits 3.5 million US workers, which is a small fraction of the 125.5 million employed workers in the US.

Many advocates of the tax plan have said that the plan won’t lead to immediate wage gains but will lead to increased profitability in the future, which should lead to increased investment, more jobs and higher wages. Even if this was the outcome, economists including Lawrence Summers, former Treasury Secretary, points out that the benefits may not be as large or immediate as Donald Trump promised (Trump predicted that tax cuts would increase the average American household income by $4000). Recent developments suggest that benefits as large as even a fraction of $4000 is unattainable, as companies are using tax windfall to buy back stocks rather than increase spending on plant and equipment. Dan McCrum of the Financial Times, recently wrote that the proportion of sales spent on research and development in S&P 500s is still yet to recover to pre-2005 levels.

Summers also points out that there is no need to eliminate estate tax as only 0.2% of US households actually pay it. In fact, the households affected by the estate tax fall between the 95th and 99th percentile of all US households in terms of income.

Another subject being discussed by prominent economists is the cost of the tax reform. An academic model from University of Pennsylvania’s Wharton School suggests that the reform will cause trillions of additional debt since tax revenue will decrease significantly. This could cancel out the growth effects that were expected. This also counters claims made by Treasury Secretary Steven Mnuchin that the cuts will pay off their costs.

Although the final effects of the tax reform are yet to be determined, the evidence thus far suggests that it is full of potholes and will add burden on the middle-class rather than eliminate it.




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