Today, President Trump unveiled a proposal that serves as his opening bid for the upcoming debate over tax “reform.” Unsurprisingly, the president is proposing straightforward tax cuts for the rich, which will need to be temporary because they will increase the federal budget deficit. The centerpiece of the proposal is a cut to the rate faced by both corporations and “pass-throughs” to 15 percent, accompanied by the claim that the tax cuts will pay for themselves (“pass-throughs” are businesses that pay no direct taxes but whose owners pay individual taxes on the dividends and other income they receive from the business). There are three important things to note about these proposed changes.
First, they would clearly be a windfall to already-rich households. The incidence of corporate tax cuts falls disproportionately on owners of businesses and other capital, and this type of income is incredibly concentrated at the top, with the top 1 percent alone claiming 53 percent of it in 2013.
Second, these tax cuts will not trickle down. There is simply no payoff to low- and middle-income families from cutting the corporate tax rate. We’ll touch on this more in an upcoming paper, but briefly, corporate tax cuts are terribly inefficient fiscal stimulus relative to nearly any other tax cut or spending increase. And the textbook channel through which they boost long-run growth—boosting savings—will not materialize. The U.S. and global economies are glutted with savings, so boosting incentives to save helps nothing.
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Third, the tax cuts will not pay for themselves. Claims that they will are pure economic innumeracy. And since they will not pay themselves, they will not even boost national savings, since any boost to private-sector saving they spur will be matched by a decline in federal savings (i.e., rising budget deficits). We tried the policy experiment of cutting taxes on capital-based incomes in the early 2000s, and all we got to show for it was the then-slowest economic recovery on record.
Finally, a 15 percent rate on pass-through businesses is nothing but a loophole. Reducing the pass-through rate will not help the large majority of genuine “small businesses.” Instead it will help private equity managers and people like President Trump: wealthy people who will now be able to reconfigure their taxes by reclassifying themselves as independent contractors. This isn’t theory, this is exactly what happened in Kansas.
The Trump proposal is a very big step in precisely the wrong direction. The corporate income tax is steeply progressive, and genuine tax reform should be raising more money from the corporate income tax, not less. Tax reform should close loopholes, not open new ones. Unfortunately, both the president’s and House Republicans’ opening bids show that they intend tax reform to simply mean tax cuts for the rich.