Many people still assume a big tax cut is coming. I think we won’t get any tax cut at all—but if we do, it will cause another problem.
In other words, we’re going to lose either way.
Here’s Why The Trump Plan Won’t Work
The tax reform wish list the White House unveiled recently isn’t exactly a “plan.” It’s more like an outline, minus the details.
Still, the goals are clear enough: Trump would reduce almost everyone’s federal tax burden and make the system somewhat less complicated.
Objections fall into two categories:
1. The biggest tax reductions would go to the wealthy.
There’s truth to this, but it’s hard to make the math work differently. The top 20% of Americans pay 84% of all income taxes. You can’t cut someone’s taxes unless they pay taxes.
Of course, the 40% of Americans who are “income tax-negative” still face payroll, property, sales, and assorted other taxes. Maybe it would make sense to cut some of those, but that’s largely a state and local matter.
2. The tax cut would blow up the deficit.
This one has more merit. No one has figured out how to cut income taxes in a way that is both politically balanced enough to get through Congress and neutral to government revenue.
That’s necessary because we obviously can’t cut spending. The president’s budget proposal shifts money from other departments to defense but doesn’t reduce the total.
As a result, the Trump administration didn’t even try to keep the plan revenue-neutral with spending cuts. They instead claim it will spur economic growth, which will create more future tax revenue.
Is that true?
Probably—but not to the extent they hope. Lower tax rates should spur a little more business investment and consumer spending. Few economists think it will be enough to fully offset the lost revenue.
(Brief tangent: I really don’t like describing tax cuts as “lost revenue” for the government. The government can’t lose what it never owned. Your income is yours first. You simply keep whatever amount Washington allows. I use the phrase only as convenient shorthand, reluctantly.)
The Deficit Will Explode
But deficit spending isn’t really the problem. Our disease is excessive spending. Deficits and too-high taxes are merely its symptoms.
All government functions cost money to deliver; that’s why we have taxes. The real issue is we have let government grow to a size where it now needs $7.03 trillion to get by (that’s how much federal, state, and local governments combined will make in fiscal year 2017).
Looking at the big picture, it doesn’t matter if the government funds itself with a). taxes now or b). borrowing now and taxes later. Both funding methods divert equal sums from private sector uses that could be more productive.
Longer term, though, it makes a huge difference.
Suppose I’m wrong. Suppose a series of miracles will give Trump everything on his wish list. Then what?
Unless another series of miracles cut government spending to the bone, we will get huge budget deficits.
The Treasury will issue more bonds to finance the deficit, crowding out private borrowing and forcing interest rates higher.
Higher rates will send the dollar up against other currencies, hurting US exports and corporate earnings.
At some point, long-term bond yields will look more attractive than stock dividends. Then stock prices will adjust lower… maybe a lot lower.
And while this unfolds, the Federal Reserve may be raising short-term rates and winding down its bond portfolio.
Not to mention that we’re overdue for a recession and first-quarter GDP looked dismal.
Be careful what you wish for.
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