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This past week, House Republicans released their comprehensive tax plan, which received decidedly mixed reviews. The plan contains many contentious provisions dealing with the individual income tax, which I shall pass by here to concentrate instead on the two most dramatic proposals: to cut the corporate tax rate from 35 percent to 20 percent, and to reduce the tax on bringing back assets now held overseas from current levels, which today run as high as 35 percent, to a one-time tax of 12 percent on cash and 5 percent on illiquid assets. The dispute on the first concerns the impact of tax reduction on working-class incomes. On the second matter, the question is whether the money returned will enrich only corporate shareholders or have additional collateral benefits.
Regarding the first point, Kevin Hassett, the head of the President’s Council of Economic Advisors, claims that these large tax cuts will pay for themselves, and predicts that middle-class families that make around $83,000 per year will earn additional wages of between $4,000 and $9,000 once the full benefits of the tax reductions are realized. Those gains do not flow primarily from a change in tax brackets, which are sufficiently low that it is hard to cut them further. Instead, Hassett claims the lion’s share of the gains will stem from the increased expenditures on new businesses and new capital assets, which will, in turn, stimulate wage growth. As a Trump administration white paper observes, wage growth has nowhere to go but up. Under the Obama administration, wage increases averaged only 0.3 percent per annum, notwithstanding the administration’s explicit effort to make wage growth the centerpiece of its overall economic agenda. Direct efforts can’t work when many wage earners pay little or no income taxes. So indirect measures intended to spur wage growth are the only game in town.
One obvious point in favor of the Trump administration’s position on corporate tax rates is that the United States has lagged in the international tax derby; its 35 percent corporate rate is far higher than the rates of its major competitors, which are on average between 10 and 22.5 percent lower. Those hefty rate differentials have sent many American corporations overseas, while inducing foreign investors to decrease their stakes in the American market. Corporate financiers are experts at calculating internal rates of return, making it highly unlikely that tax breaks of this magnitude will not alter their behavior. The hard question is not whether tax cuts will stimulate activity, but, empirically, what the size of that response will be.
I hope the current Washington political turmoil doesn’t torpedo tax reform. It would be an important element — though not the only one — in boosting the US economy’s growth potential by raising productivity. As a new Capital Economics report notes, US business investment as a share of GDP has been trending lower since the late 1990s. And that may be feeding into chronically weak productivity gains since the Great Recession.
From the report: “According to the BLS, the contribution from capital intensity (aka capital deepening) fell from an average of 1.0% between 2000 and 2007 to 0.5% between 2007 and 2016.” (The above chart from the firm provides a breakdown.)