by Adam Michel
On December 22, 2017, President Donald Trump enacted the most significant changes to the United States tax code in more than three decades by signing the Tax Cuts and Jobs Act (TCJA) into law.
Beginning in 2018, the new corporate tax rate will be 21 percent, down from an internationally high 35 percent; noncorporate and “pass-through” businesses (mostly small firms whose profit or loss is reported as personal income by their owners) will receive a new 20 percent deduction. The bill also allows temporary full expensing and moves toward a territorial tax system.
For individual taxpayers, the bill lowers tax rates, doubles the standard deduction and expands the child tax credit, among other changes.
A recent WSJ/NBC survey found that 17 percent of respondents thought they will get a tax cut. In reality, both the government’s scorekeepers and the liberal Tax Policy Center estimate that more than 80 percent of Americans will see their taxes lowered. Only 4.8 percent will see a tax increase, most of whom are in the top 10 percent bracket of income earners. A typical taxpayer can expect a tax cut of some $2,000.
The final legislative product represents a serious effort to reform a complex and badly broken system. The bill is not without its challenges, but the business reforms alone are expected to stimulate growth, leading to higher wages, more jobs and greater opportunity in a bigger and more dynamic economy.
Business investment in the U.S. is unusually low. Over the past decade, the contribution of new business investment to labor productivity growth has dipped into negative territory. Subpar investment has created huge problems for the American economy – wage growth is stagnant and new business startups are at a historical low.
Attracting more domestic investment to areas such as manufacturing, machinery and workforce expansion and training is the primary goal of this tax reform.
American businesses and the workers they employ have long been on the losing end of a battle for global investment. For years, U.S. businesses have faced some of the highest statutory corporate tax rates in the world. By other measures too, the country was at the back of the pack when it came to business tax systems.
Reforms in the TCJA work to turn these trends around. A new 21 percent corporate tax rate promises to break the current investment drought. Moreover, for five years or more, all businesses will be able to immediately write off the costs of new equipment. This provision, called “expensing,” lets businesses invest more in the U.S. and supercharges the pro-growth benefits of the new lower tax rates. Businesses have already pledged to expand in the coming year. AT&T Inc. has committed to investing $1 billion in U.S. infrastructure and jobs in 2018. Boeing, Wells Fargo, Comcast and many smaller companies also announced pay increases, bonuses and other new spending as a result of the tax reform.
In a recent survey of business CEOs, 14 percent said they expect to make “large, immediate domestic capital investments” following the TCJA. More can be expected to follow in the coming years.
Estimates of how the tax bill will affect the pace of economic growth vary, but the trend is clear: any reform that lowers the corporate tax rate and provides for expensing will be a significant boost to investment and long-term economic output. As passed, the TCJA will result in a 2.2 percent expansion of gross domestic product over the long run (with most of this increase occurring within the first 10 years). Independent analysis from The Heritage Foundation, The Tax Foundation and Boston University have all found that the tax reform, if made permanent, would result in an economy more than 3 percent larger than it would have been otherwise.
According to a 2015 report by the Federal Reserve Bank of Chicago, investment per worker is 8 percent below the historic norm in the U.S. If investment returned to its previous trend line, wages could grow by 13 percent, or about $6,500 a year, according to a conservative estimate. The tax reform is expected to contribute about half of that wage growth.
Even government scorekeepers (who consistently underestimate the pro-growth impact of tax reform) and the liberal Tax Policy Center predict a boost to economic growth following the new legislation.
The economic maxim that the true level of taxation is the level of spending means that all tax cuts are temporary if spending consistently outpaces revenue.
One of the most persistent arguments against tax reform is that it will increase the national debt. This is a misdirected criticism.
When taking into account the economic growth from tax reform, the TCJA will be a onetime addition to the $20 trillion national debt of about $400 billion. After a decade, increased revenue is projected to fully cover the tax cut. Meanwhile, spending is projected to increase by $10 trillion over the next 10 years.
However, deficit hawks are right to be concerned about the seemingly never-ending additions to the debt. Congress has not accumulated $20 trillion of debt because people are not taxed enough. The U.S. Treasury is projected to collect more revenue this year than the historical average. The U.S. is in debt because Congress has a spending addiction.
Revenue is certainly not the problem. Even under the current tax reform scheme, the size of the proposed revenue reductions is miniscule compared to the coming spending increases.
Regardless of the TCJA, without spending-based reforms, deficits will continue to grow, requiring higher taxes in the future.
In the face of rising deficits and an unwillingness to address increasing spending, legislators have historically sought new sources of revenue or allowed tax cuts to expire. Portions of President Ronald Reagan’s tax cuts in 1981 and President George W. Bush’s cuts in the early 2000s were ultimately reversed. Thus, spending reforms are a critical component of sustainable tax reform amid high government deficits and debt.
The U.S. Congress is facing a stark choice at this point. Lawmakers can control spending so that Americans can enjoy their new tax cuts and enhanced economic freedom, or federal programs can stay on an uncorrected course, forcing tax increases to cover the projected extra expenditure. If spending growth continues on trend, within 10 years taxes as a percentage of GDP will need to shoot up by roughly 35 percent to cover the federal government’s yearly obligations.
In 2025, most of the individual and many of the business tax cuts revert to previous law, to meet political constraints and Senate budget rules. Congress will need to revisit the tax code in coming years to keep taxes from going back up. If lawmakers are unwilling to address the entire federal fiscal picture, then the American people ultimately will be forced to foot the bill for unchecked profligacy.
The future of tax reform remains murky, but Congress does have an opportunity to embark on even more far-reaching and permanent reforms. If it chooses to do so, the country’s position as a global destination for business investment would be solidified, and American workers would surely benefit.
Adam N. Michel is a Policy Analyst in the Thomas A. Roe Institute for Economic Policy Studies at The Heritage Foundation.