Donald Trump’s unsustainable tax cut for the rich
By Jonathan Haughton | October 13, 2016, 10:08 EST
Second only to lawyers, economists are the subject of frequent jokes. For example: “If all the economists were laid end to end, they would never reach a conclusion.” The follow-up joke is that “if all economists were laid end to end, that would be a good thing.” Yes, economists can disagree. Yet, they can agree, as well.
We, along with three co-authors, recently finished a series of studies of the Trump and Clinton tax plans. We all signed off on the methodology and the findings. You can see these studies at www.beaconhill.org.
Here are the principal features of Trump’s plan:
— Reduce the number of non-zero tax rates from seven to three (12%, 25%, and 33%);
— Abolish the Alternative Minimum Tax;
— Cut the business tax to a flat rate of 15%;
— Abolishes the estate tax;
— Increase the standard deduction to $20,000 for single filers and $40,000 for married couples filing jointly; and
— Introduce a child care tax deduction.
Here are the principal features of Clinton’s plan:
1. Add a surcharge of 4% on adjusted gross annual income above $5 million;
2. Limit the value of deductions (except for contributions to charity) to no more than 28% of their value;
3. Ensure that all taxpayers with a modified adjusted gross income of $1 million or more would pay at least 30% of their income in taxes (the “Buffett Rule”);
4. Increase the tax rates applicable to capital gains for those in the top income tax bracket;
5. Repeal carried interest, which is a provision that allows general partners in some businesses to book most of their earnings as (low-taxed) capital gains rather than earned income; and
6. Increase the estate tax.
In our studies, we agreed that the two plans would have very different effects on the economy. The two of us did not agree, however, on which plan was better. In conversation over our findings, one of us favored Trump’s plan, the other Clinton’s.
How is this possible, considering that we agreed on a very wide range of economic effects? The answer is that economics, like any science, utilizes theoretical models that work by showing how changes that take place outside a model (e.g., tax policy changes) affect variables that are determined inside the model (e.g., investment and employment). The alternative tax plans we considered called for very different changes in current tax policy and thus yielded very different results, making it difficult to agree on which results would be better for the country.
So we agreed to disagree. Here is Jonathan Haughton’s opinion of the two plans. For David Tuerck’s, read HERE.
Donald Trump’s unsustainable tax cut for the rich
Every introductory economics class begins by asserting that the discipline seeks to answer three basic questions: what should an economy produce, how, and for whom. For too long we have devoted most of our attention to finding ways to increase what we produce, while overlooking the issue of for whom.
Donald Trump has proposed tax cuts that may raise how much we produce, but would channel seven-tenths of the benefits to the top 10% of American society. Hillary Clinton’s changes would have little effect on output, but would create a fairer society. Here there is a clear and stark choice that goes well beyond disinterested economic analysis to the moral choices that we make as a society.
Let me be more specific. Over the coming decade, Trump’s tax changes would reduce tax collections by over $8 trillion, equivalent to a drop of 20% in revenue. If spending is not cut, then the federal budget deficit will climb to an average of nearly 8% of GDP, which is twice the level projected by the Congressional Budget Office, and is clearly unsustainable. Contrast this to Clinton’s proposals, under which the deficit (again assuming no change in spending) would shrink slightly over the coming years, clearly the fiscally responsible option.
Perhaps Trump is hoping that lower tax revenue would “starve the government beast”, in which case one has to wonder which programs he would attack: since 60% of federal outlays consist of legally mandated spending (on items such as social security and Medicare), he would have to cut the remaining “discretionary” spending in half in order to remain within budget. That would leave us with half an army, half a coastguard, and half a National Science Foundation. Clinton’s budget would wreak no such havoc.
But let’s set aside the issue of whether Trump’s numbers add up, and ask who would benefit from his proposed tax cuts. Our numbers – based on a set of reasonable assumptions about who really bears the burden of taxes (their “effective incidence”) – are clear: 70% of the benefits of the tax reductions would go to the most-affluent 10% of Americans, while 10% would go to the bottom half of the population. By any standard of fairness, this is a giveaway to the rich. On average, those in the top 10% of the income distribution would get over $15,000 in tax reductions annually, while those in the bottom 10% would gain the princely sum of $300 per year.
The explanation is clear: Trump’s tax cuts would disproportionately reduce taxes on the rich. The abolition of the estate tax would only benefit those who stand to inherit at least $4.5 million, and these folk make up no more than 0.2% of the population. Those who amass enormous fortunes may feel that they deserve every penny that they earn – if they did not inherit it, that is – but nearly everyone who has built up tens or hundreds of millions of dollars in assets by the time they die has also had more than their fair share of good luck. Society has allowed them to enjoy this good fortune while they are alive, but it is surely right and proper that some of this rent be inherited by the society in which they prospered, and not just by their heirs.
The cut in taxes on capital to 15%, which would mean many working people would be paying higher taxes than rentiers, favors those with large fortunes. On paper, the US may have the highest corporation taxes in the world, but in reality our average effective corporate tax rate is slightly below the average of other rich (OECD) countries. There is a strong case for a simpler corporate tax structure, but not for rock-bottom rates.
And the cut in the top income tax rates proposed by Trump would, by construction, largely favor high earners, stripping the tax system of one of the few elements that make it progressive.
By way of contrast, six-sevenths of Clinton’s proposed tax increases – which are really very modest, averaging just 0.2% of income – would land on the richest 10%, while they would barely affect the great majority of Americans. This is not the stuff of class warfare, but it reflects an overdue recognition of the importance of fairness, both in its own right, and for the sake of greater social cohesion.
But wait, would not Trump’s tax cuts (assuming we ignore the overall fiscal effects) stimulate investment and work? Indeed they would, and our computable general equilibrium model suggests that, on average, personal income could be almost 6% higher in 2026 than would otherwise have been the case. But this bigger pie is of little comfort to the bulk of the population, who would gain so little, relative to those who are already economically fortunate, that they would continue to feel aggrieved. This is not trickle-down economics; it is drip-down economics.
The U.S. tax system is ripe for reform. It could collect at least as much money as it does now, but in a fairer and more efficient manner, so it is unfortunate that neither candidate has proposed a compelling package of tax reforms that would broaden the tax base, cut inefficient loopholes, and trim high marginal tax rates.
But even if the perfect tax reform is not on the table, there is at least a clear choice: large tax cuts that mainly favor the rich, would boost economic growth, but are likely unsustainable; or modest tax increases that are fiscally responsible, and inject a modicum more fairness into our highly unequal society. As an economist, I can outline the choice. As a voter, I plan to opt for the latter.