Tax Reform Not Perfect but Good for All Americans by David Montgomery

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If you only watch channels like CBS or CNN or read the Washington Post, you are no doubt convinced that the Republican tax reform bill announced yesterday has the sole purpose of taking money from the poor and middle class and handing it to businesses and the rich. There is a fundamental error behind that thinking. Tax policy is not just a zero-sum game – changes in tax law can make the pie larger or smaller as well as influencing who gets a bigger slice. And increasing the size of the pie is the whole purpose of the proposed tax reforms.

Nancy Pelosi is already complaining that the reduction in the corporate income tax rate from 35% to 20% is the largest reduction ever made in corporate taxes. She does not mention that the 35% rate American businesses now pay is the highest of any developed country, and the 20% rate will put us back into the middle of the pack. But what she and the other Progressives try to conceal is that tax reform will eliminate the incentive that American businesses now have to move their assets, factories and patents overseas, giving jobs and tax revenue to other countries and eliminating them here.

The corporate rate reduction is the most important part of the proposal for encouraging investment in the United States, and without it tax reform would be meaningless. In addition, the proposal will reverse the incentives that have caused American corporations to leave their foreign earnings on the books of their overseas branches in order to avoid taxes. In an arcane section at the end, the proposal will put a one-time tax on all past earnings held overseas, just as if they had been brought back. Thereafter, U.S. companies will be able to bring those earnings back for investment or dividends in the United States without paying taxes, thus freeing up more funds for investment here.

Finally, high corporate taxes have motivated many companies to register patents overseas and charge themselves high royalties that go to their foreign affiliates that pay little or no tax. The proposal will put a 20% additional tax on payments to foreign affiliates to eliminate the possibility of sheltering income from patents and other intangible assets. That provision is not as strong or effective as the abandoned border tax adjustment, but it will be a help to keep R&D at home.

The result of this reform of business taxation is not just higher profits for those companies. It will help everyone who owns shares of U.S. businesses in their 401(k) retirement funds, not just wealthy executives. Possibly more important to businesses on the Eastern Shore, tax reform will also limit to 25% the maximum tax rate that must be paid by owners of small businesses on the earnings of their C or S corporations that flow through to their personal taxes.

The effects of these changes in business taxation have been grossly misrepresented by the opponents of tax reform. The loudest claim by left-wing economists is that the proposals are “just another example of the discredited trickle-down theory.” Contrary to every principle they teach, these progressive true-believers speak as if heavy taxes have no effect on wages or job growth. They also have an odd reading of history. In the past eight years, we have seen an explosion of regulation and higher and higher taxes on business – and still, wage and job growth are stalled. Seems to me that pretty much proves the trickle-down theory – tax and regulate businesses to death and wages and job opportunities will fall. Relieve business of taxes and regulation and wages and job opportunities will grow.

Independent studies of the effects of the Ways and Means proposal show how this would work. First of all, all income groups will benefit from the personal tax reductions. Poorer working people will pay no tax, and every income group will pay less. With the increased standard deduction, most families will no longer need to itemize deductions, and this means more than saving time and money on tax preparation.

There is a great deal of self-interested and deceptive agitation against limiting deductions of state and local income taxes and mortgage interest. These deductions mean a lot to real estate agents and mortgage brokers who get more business from the subsidy to home purchases and to state and local governments that get less pushback against tax increases because they are tax deductible. And most of the increased revenue that would come from limiting these deductions will be paid by those in the highest income groups. With the increased standard deduction and personal exemptions, these deductions become meaningless because the standard deduction is a bigger benefit to most low and middle-income taxpayers. So this is not taking money out of the pockets of the middle class, it is fixing a subsidy to the rich. According to the Tax Foundation, 88% of the benefit of the state and local tax deduction goes to taxpayers with incomes over $100,000. Even the Treasury Department has labeled the deduction a perverse subsidy to the rich.

The Tax Foundation also estimates that the specific reforms just announced by the Ways and Means Committee will increase U.S. employment by about 1 million jobs after 10 years of increased economic growth, increase wages by 3.1%, and make middle-income families better off by about $2500 annually.

Maryland fared even better, with an increase of over 18,000 jobs and increased income for a middle-income family of $3,250. The proposed set of tax reforms are a rare example of a policy that is good for all Americans. Not perfect: keeping the border adjustment, reducing personal taxes on investment income further, and making expensing of all investment permanent would have given about three times the benefits, but good enough to deserve bipartisan support.

David Montgomery was formerly Senior Vice President of NERA Economic Consulting. He also served as assistant director of the US Congressional Budget Office and deputy assistant secretary for policy in the US Department of Energy. He taught economics at the California Institute of Technology and Stanford University and was a senior fellow at Resources for the Future.

 

 

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Letters to Editor

  1. Neil Armstrong says:

    I’m sure Mr. Montgomery would agree that passing a partisan bill with this kind of impact on the economy is not good policy. Democrats seem to be completely locked out of making any impact. Also, he did not make any mention of the large deficit increase that will result from this measure! For eight years of the Obama administration Republicans were deficit hawks, frustrating Obama’s attempts to stimulate growth through repairing our infrastructure. What hypocrisy. This measure will just widen the gap income gap and not come close to being paid for.

  2. Carol Voyles says:

    Tax reform should benefit all Americans. But let’s face it, the problem with the current plan is that it creates more debt (What? “Deficits don’t matter,” again?), while those who need it least benefit most. The middle class would appreciate a $1-2,000 windfall after decades of wage stagnation – and some could get one until their deductions timed out. Let’s hope those enjoying our record level of income disparity most might be half as appreciative of that extra million or so in their bank accounts. (Tax Policy Center)

    And what about corporate tax deductions? Have yet to hear of an elimination, although effective rates are allowing most corporations to be competitive internationally. Some are paying nothing, though.

    Let’s at least hope that “self-interest’ and “deception” are eliminated before pass-through avoidance strategies take hold.

  3. David Montgomery says:

    My readers seem to have missed the point of my discussion of how tax reform will stimulate more economic growth. That increases the tax base and revenues to offset the $1.5 Trillion static estimate of revenue loss that takes no account of those dynamic effects. As I write this, we await the score that the JCT and CBO will give to the proposal, but it is expected to come in well below $1.5 T. Taking into account the additional revenues from economic growth, the actual effects on the deficit are likely to be very small — a couple of hundred billion.

    Nor am I much impressed with the comment that “passing a partisan bill with this kind of impact on the economy is not good policy.” Does no one remember that is how Pelosi and Reid pushed through Obamacare. It would be very desirable to have bipartisan agreement on tax reform for growth, but it is up to the Democrats whether they want to switch from pure obstruction to negotiation.

    And most corporate welfare is being eliminated as part of this package, only the R&D and low income tax credits are retained. Every other special favor in the tax code to business is eliminated. Sometimes, as in the case of renewable energy credits, they are phased out more slowly than I would like, but still they will all disappear.

  4. Rod Coleman says:

    The tax plan currently proposed by the House Republicans is so bad it is difficult to decide where to start in discussing it. So to make things a bit easier, I’m going to focus on just two numbers: $1.5 trillion and $37 million.

    $1.5 trillion is, of course, the amount that the Republican plan would add to the US debt over the life of the plan. Remember the Tea Party, ending deficit spending, all that silly boring responsible stuff? Well, it seems all those folks have fallen in the swamp. At a time when the US economy is growing and we should by any responsible measure be paying down debt, not accumulating more, this plan gleefully proposes to…..accumulate more debt!

    Now $1.5 trillion is a big number, and big numbers tend to be hard to wrap your head around. So let’s make it a bit more manageable. The current US population is roughly 325 million, divided into 126 million households (2.6 persons per household). So the average increase in each US citizen’s share of the US debt will increase by $4,615, or $11,900 per household. And yes folks, the government debt is OUR debt, something that seems to get lost in this discussion at times.

    Now let’s look at that other number: $37 million. That’s the amount Donald Trump, now President Trump, paid in Alternative Minimum Tax in 2005 (the one year for which we have seen his returns). Without the AMT, Mr Trump would have paid only $7 million in taxes; with the AMT, he paid $38 million. His reported income in 2005 was $158 million, so his overall tax rate was 24% with the AMT, and would be 4% without.

    Now the stated goal of the AMT when passed into law in 1969 was to ensure that wealthy Americans pay a fair share of the tax burden. In other words, regardless of all the tax shelters, subsidies, deductions, allowances, etc, at the end of the day you need to pay a fair share. There are a great many arguments about whether or not the AMT is actually effective in ensuring a fair tax burden, but it is what we have and it’s at least an attempt at fairness (armies of lawyers and accountants not withstanding).

    The Republican plan would repeal the AMT and replace it with….nothing! So Trump’s 2005 effective tax rate would become 4%. I’ll leave you to judge the fairness of that, and who this plan is truly intended to benefit.

    I suspect Mr Montgomery and other of Mr Trump’s supporters will picture me as a sore-headed loser who hates the wealthy and wants to raise taxes on all those rich folks and cut my own. In fact, I used to call myself a Republican and I’ve paid the AMT many times over the years. Not $30+ million, but many, many thousands (which is real money to me). I’m not going to say I was glad to pay it, but pay it I did, because I understood that (a) governing the greatest nation in the history of mankind is an expensive proposition and (b) paying a fair share of that expense is the duty of each of us as citizens.

    Mr Trump and the House Republicans apparently believe that paying taxes is for suckers and fools. And as P.T. Barnum (who might have been Donald Trump in a previous life) famously said, there’s a sucker born every minute. Under this plan, those suckers will be born $4,615 deeper in debt.

  5. Joan Wetmore says:

    David Montgomery should look at the proposed bill again. It hits the middle class hard by greatly reducing and/or doing away with the home mortgage interest deduction, as well as the deductions for state and local income taxes. At the same time, it greatly increases the deficit. How is that “good for all Americans?!”

  6. David,

    Seriously? We have not missed the point. Stimulating growth? To what end is the real question.

    I find it so amusing and very tragic that “your” party wants immigration reform, but only after the border is sealed, yet will promote lower corporate taxes without closing the holes in that wall first. Is the irony and hypocrisy so hard to see?

    Do you remember the John Prine song, “There’s a hole in Daddy’s arm where all the money goes”? Well, there is also a well of greed in many of the corporate boardrooms in America where all the money goes. In the mildly descriptive and vernacular of “our” verbally challenged President, “SAD, VERY SAD.”

    I, too, favor a lower corporate tax rate and my company would benefit, but it should be tied to a Alternative Minimum Corporate Tax as well or it is just a sham.

    Here is a reprint from the WSJ. Hopefully, reposting this is acceptable.

    A Ford Exec Who Took the Long View

    Populism could intensify if corporate tax cuts don’t yield benefits for workers.

    By William A. Galston
    Nov. 14, 2017 6:18 p.m. ET

    The older I get, the more drawn I am to obituaries, but not for the obvious reason. They often offer a reminder of the United States as it used to be, and they make me wonder whether we have lost something precious.

    I had one of these moments this weekend, when I read about the death of Arjay Miller, 101, who was president of Ford Motor Co. and later dean of Stanford Business School. Under Miller’s leadership (1963-68), Ford modernized its management, introduced the highly successful Mustang, and achieved record earnings.

    At the same time, Miller made Ford take automobile safety seriously while General Motors lagged behind. The choice cost Ford sales because some customers balked at paying for innovative equipment such as seat belts. Miller defended his policy as the right thing to do and said corporate leaders should always ask themselves whether they were willing to have their decisions publicly reported.Volkswagen executives have paid dearly for ignoring this advice, and they are not alone.

    After leaving Ford, Miller helped move Stanford into the top rank of business schools by diversifying the faculty and student body while expanding coverage of ethics and public policy. He founded the Economic Development Corporation of Detroit, supported black-owned and -operated business, and backed a negative income tax to reduce poverty. “Making money is the easy part,” he declared. “Making the world a better place is the hard part.”

    I wonder how many of today’s executives would be prepared to sacrifice sales and profits to do the right thing. Most of them have been taught that maximizing shareholder value is their sole responsibility—and if this means ignoring the needs of workers and the well-being of local communities, so be it.

    Miller’s example is especially relevant today, as Republicans in the House and Senate consider tax legislation that would allow corporations to repatriate foreign assets at concessionary rates. The bills’ drafters are assuming that executives will use these funds to invest in their businesses.

    But that’s not what happened the last time this was done, in 2004, when corporations were allowed to bring back overseas assets if they paid a tax of only 5%. During the next three years, the 15 companies that repatriated the most raised salaries for senior executives, cut more than 20,000 jobs, decreased investment in research, and expanded dividends and stock buybacks. All this happened despite the letter of the law, which specified that the funds be used for investing in research and the workforce and prohibited their use for compensating executives and repurchasing stock.

    Law is a blunt and often ineffective instrument for inducing corporate leaders to take a broader view. They have enormous discretionary authority. The question is how they choose to use it. Legality is just the beginning. “Moral judgment transcends legalities,” Miller once said. So does moral responsibility.

    The tax bills now under consideration in the House and Senate represent the largest corporate tax cuts in many decades. If these bills pass, average Americans will expect something in return—higher wages, better working conditions, and more opportunities for their children. If corporations take the money and run, public retribution will be severe.

    Earlier this week, a group of 400 rich Americans sent a letter to Republican members of Congress. Their message: don’t cut our taxes. We don’t need the money; others do. Besides, it is folly to add $1.5 trillion to already dire forecasts of the growth of the national debt over the next decade.

    This is a good start. But in addition to political responsibility, America’s financial elite ought to exercise business responsibility. America needs a new era of broad-minded, socially aware corporate leaders who understand the long-term relationship between the well-being of their companies and the well-being of their country.

    An environment in which profits soar while wages stagnate may make for satisfied shareholders. But the revolt against the arrangements that sustain this imbalance is already under way. Today the targets are immigration and trade treaties. Tomorrow the demands could include restrictions on the ability of corporations to shutter plants and fire workers at will. The day after tomorrow, if massive corporate tax cuts yield no benefits for workers, we could see an intensified revolt against elites, not only cultural elites, but the captains of industry and finance as well.

    Taking the long view is self-interest rightly understood. It means refraining from squeezing the last bit of profit out of your business right now in order to secure a flow of profit over time. The economy rests on a set of political arrangements that the people can revise and—if things get bad enough—upend.

    Appeared in the November 15, 2017, print edition.

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