Can Tax Cuts Stimulate the Economy?
President Trump’s tax proposal has four goals: (1) to “make the tax code simpler,” (2) to “give employees a raise” by reducing their income taxes, (3) to “level the playing field” by cutting taxes on American companies, and (4) to provide incentives for businesses to “bring back” the $2.5 trillion of cash they hold overseas.[i]
‘Make the Tax Code Simpler’
The plan reduces the number of tax brackets from 7 to 3, eliminates most deductions, and removes exemptions for dependents. But the plan intends to offset these tax-increasing policies by doubling the standard deduction. It also eliminates the alternative minimum tax, a complex parallel tax system that operates in the shadow of the regular tax.
‘Give Employees a Raise’
The American worker needs an increase in pay. According to the Hamilton Project, adjusting for inflation, American workers have seen their pay go up just 10% since 1973, or a measly .2% per year.[ii]
However, David Stockman, President Reagan’s first budget director, says most taxpayers pay so little in income tax that not much can be cut to provide that raise: “101 million taxpayers (69%) have no exposure to the complexity of the IRS code at all. They owe virtually nothing. Moreover, I mean nothing. Among the 148 million income tax filers, the bottom 53 million owed zero taxes in the most recent year (2014), and the bottom half (74 million) paid an aggregate total of just $45 billion.”[iii]
‘Level the Playing Field’
At approximately 39.1%, the United States has the world’s third-highest marginal corporate tax rate. Only Chad and the UAE have higher ones. However, because of deductions and write-offs, most companies never pay that rate. In fact, in 2011, the average rate was only 12%.[iv] And, with corporate profits and the stock market at all-time highs, the idea that U.S. corporations are overtaxed seems a stretch.
‘Bring the Money Home’
President Trump’s proposal mentions “bringing back trillions of dollars that are currently kept offshore to reinvest in the U.S. economy.” Yes, corporations do have $2.5 trillion overseas. But Goldman Sachs estimates that, of that amount, $920 billion has never been taxed and, based on the last time the U.S. government did foreign cash repatriation, only $250 billion of the $2.5 trillion will come back.[v]
Also, companies do not have dollars overseas; they have yen, euros, or whatever currency of the products they sold was bought. So, to bring back the money, the companies must first convert that country’s currency into dollars—that is, someone has to sell them their dollars. Thus, no matter how much money comes back, the net dollars for investment here stays the same.
A Better, Simpler Tax Plan
Wealth and income in the U.S. are more concentrated now than at any time except maybe right before the Great Depression. Because of this, the wealthy do pay most of the income taxes. They also own most of the stocks, so any incentive to bring corporate cash home (which could increase the value of equities), together with a reduction in the income tax rate, disproportionally benefits them.
The only exceptions are the payroll taxes, i.e., the Social Security tax. High earners stop paying this tax after their income reaches $118,500. Also, there are almost no deductions or exemptions for paying this tax. So any cut to it benefits middle- and lower-income people more. And they might actually spend the money in their paycheck, which could help the economy grow faster.
[i] “Read President Trump’s Tax Proposal,” The New York Times, September 27, 2017, https://www.nytimes.com/interactive/2017/09/27/us/politics/document-Read-President-Trump-s-Tax-Proposal.html
[ii] Roberts, Lance, “Fed Study: The Bottom 90% & The Failure of Prosperity,” Bloomberg News, August 7, 2017, https://realinvestmentadvice.com/fed-study-the-bottom-90-the-failure-of-prosperity/
[iii] Roberts, Lance, “Fed Study: The Bottom 90% & The Failure of Prosperity, Bloomberg News, October 2, 2017, https://realinvestmentadvice.com/fed-study-the-bottom-90-the-failure-of-prosperity/
[iv] Paletta, Damian, “With Tax Breaks, Corporate Rate is Lowest in Decades,” The Wall Street Journal, February 3, 2012, https://www.wsj.com/articles/SB10001424052970204662204577199492233215330
[v] Stewart, Emily, “20 Companies Goldman Sachs Thinks will be Huge Winners from Trump’s Big Tax Plan, The Street, October 2, 2017, https://www.thestreet.com/story/14325633/1/trump-tax-plan-goldman-sachs.html
These are the opinions of Tim Hayes and not necessarily those of Cambridge Investment Research. They are for informational purposes only, and should not be construed or acted upon as individualized investment advice.