May 3, 2017    5 minute read

The Trump Tax Plan: An Oxymoron

Short on Detail    May 3, 2017    5 minute read

The Trump Tax Plan: An Oxymoron

The term ‘oxymoron’ suggests two words or concepts that are inherently contradictory. In this case it is three.

Taxes, as this author has argued through several posts, are important. There is $3.7trn of federal expenditure that has to be funded. Taxes are the source of this funding and the sources and uses are in increasing tension.

The goal of maximising taxes is best achieved by stimulating more economic activity  – increasing the tax base. The challenge is to set the tax rate at a level just below the point at which it would discourage economic activity and therefore become counterproductive.

Taking the Process Seriously

A recent VOX article on the economist Arthur Laffer suggested that the discussion about tax rates and economic activity has been misinformed by the concept of the Laffer curve. The curve is considered exhibit 1 for the case that reducing tax rates in the US would unleash businesses to get busy both producing and reporting vast amounts of revenue which would boost tax revenues even at a lower rate. Accordingly, this article suggests, economists and policy makers have been operating on bad information since 1974.

The Trump tax plan is, of course, less a plan at this point than it is clickbait. It seems as if Trump’s Treasury secretary would have liked to have produced a plan based on research and deliberation. It seems it would have taken a while – maybe until this summer or autumn. Who knew it was this complicated? Apparently, that timetable was not acceptable to the President, who needed a quick win. The plan was rolled out on the appointed day; Trump took credit for delivering the goods. Now, the details need to be worked out.

On the One Hand…

There are, of course, opposing views on whether this signals progress or not. Kimberly Strassel in the WSJ seems to believe it does it does. Broad outlines are precisely what the President should set out in order not to usurp the role of lawmakers. He should articulate bold ideas. Apparently that means a “big, swashbuckling vision for enacting pro-growth principles.” Strassel suggests that the plan offers something for everyone. Although she does not mention this part, boldness is measured by a willingness to accept the possibility that a reduction in tax revenues may increase the deficit – by as much as $2trn over 10 years, according to some estimates. Roll the dice, Mr President. It’s just like the real estate business: go big or go home.

Paul Krugman, commenting on the idea of  living in the Trump Zone, said that the one-page tax plan is woefully short on details but does suggest that those with pass-through corporations will benefit substantially from a reduction from 35% to 15% (according to the WSJ, $304m of the income that Mr Trump reported in a 2016 financial disclosure came through 96 pass-through limited liability companies, or LLCs) . The idea of increasing the deficit to pay for this is, Krugman suggests, a familiar one: it will be paid back in growth.

Does Increasing the Deficit Make Sense?

There is an argument for ignoring the increase in the deficit if the US government can borrow at less than 1% and, in doing so, add the 1.8% to GDP growth that the conservative-leaning Tax Foundation calculates is necessary to justify the increase in the deficit that would result from tax cuts of this magnitude.

That, of course, is a gamble. The size of the cuts is yet to be negotiated, and borrowing costs of under 1% are at the short-end of the yield curve. A more prudent measure would be to use borrowing costs to match the period over which the economic analysis is presented: the 10-year government bond yield is around 2.3%. Adding 1.6% growth to a GDP base of $18trn would, over 10 years, increase GDP by approximately $3.6trn. That may be enough. It would not, however, be sufficient to allow the President to also pay down the $19trn of federal debt in the 8 years he promised during the campaign. Things change.

The maths has yet to be figured out. Given the attention to detail shown so far by President Trump, it is unlikely that he will have the focus to work through it with his advisors. Over to Congress, then.

The Treasury Secretary Said What?

The problem with this analysis is that the numbers are simply too big to be understood by the majority of the US electorate. The first reaction of the average reader or listener when faced with a tax proposal like this one is not to consult the Tax Foundation or Club for Growth or Cato Institute websites, take out the calculator and do a few simple sums. There are too many moving parts.

Dynamic scoring – the practice of estimating the change in economic activity that would occur from changes in the tax rate – is out of reach for most voters. Voter reaction is, therefore, susceptible to being manipulated by pundits or so-called experts who are assumed to have done a few sums before writing their articles or making their speeches.

Fact-checking those articles or speeches is also not something that the average voter is inclined to do. Their inclination is to believe the pundits they trust, which tends to mean those whose opinions they agree with. And thus, as Shakespeare put it, ‘sicklied o’er with the pale cast of [complexity]…enterprises of great pith and moment with this regard their currents turn awry and lose the name of action’. Perhaps the ‘thoughtful voter’ is another oxymoron in the making.

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