A Zillionaire Explains What Is Wrong With Donald Trump's Tax Plan
There is an old truism that says "Never cut taxes in an improving economy."
Venture Capitalist Questions Fundamental Tenants of GOP 2017 Tax Cut Plan
Nick Hanaur is a self-described "zillionaire" who takes the core beliefs of GOP economics (correctly in my estimation) to task. Hanaur began as an entrepreneur in 1984 founding a successful business and ending up as an extremely successful venture capitalist in 2000. You can read the details of his bonafides in the link I provided, but bottom line ... he knows what he is talking about. What made me look was a Politico article I recently read titled A Zillionaire’s Solution: Tax the Rich and Save the Economy said in a few words what I have been trying to get across in multiple hubs. Judging from the title, you can see he and Warren Buffet have similar ideas about how taxes work. Following is an analysis of what his economic philosophy is.
Brief Overview of the GOP Tax Plan
Most details of what President Trump and the GOP have in mind for the 2017 tax reform and cut plan have yet to be filled in. But what is known as of mid-September was analyzed by the independent Tax Policy Center. The features that are currently known are:
- Significant reduction in marginal tax rates
- Increase the Standard Deductions
- Increase the Child Tax Credit
- Eliminate the Personal Exemptions
- Eliminate most Itemized Deductions (all but Charity and Home Mortgage Interest)
- Prevent businesses from deducting Net Interest Expense
- Allow businesses to expense New Investment in the year purchased
- Reduce the top marginal rate on personal taxes to 33%
- Reduce the corporate tax rate to 20%
- Cap individual Capital Gains to 16.7%
- Eliminate the Alternative Minimum, Estate, Gift, and ACA taxes
- Cap "pass-through" income to 25% (currently it is the personal rate)
The Tax Policy Center estimates, with large margins of error, that tax revenues will fall by $3.0 trillion in 10 years (taking into account interest and economic growth). The National Debt will grow by $6.6 trillions in 20 years.
Further, they estimate the average decrease in taxes for:
- The poorest 5th of American households will be $50
- The mid 5th will see, on average, will get a $260 (with the higher end of that group seeing an actual tax increase)
- The top 5th will get an average of $1.3 million each.
- By 2050, they estimate the top 1% will receive almost 100% of the tax reductions!
What the GOP is saying will fix it all is the job growth (in a fully employed economy) generated by the tax reductions will more than offset the increase in debt. Unfortunately, it seems the Tax Policy Center's dynamic modeling thinks GDP will grow by a little more than $300 billion over 10 years, enough to cover the increased interest generated by the increased debt.
A Word About the Lafler Curve
The battle between "supply-siders" and "demand-siders" in terms of tax policy is "At what tax rate does government maximize its tax revenue?" This is the question President Reagan asked of Professor Laffer back in early 1980s. The answer was Chart 1 below.
While Laffer was not the first to have this idea, he was the one who formalized it in a theory Reagan could buy into. Stripped down, Laffer claimed that over all tax revenue suffered when tax rates where very high and that, for various reasons, they would increase if tax rates decreased. But, and there is always a "but", if you lower them too far, then total tax revenue will decrease until it drops to zero when the tax rate is zero. Today, almost all economists on the Left as well as the Right agree with Laffer's idea.
Laffer Curve: Basis of Reaganomics
The challenge, of course, is to find the "sweet spot" where total tax revenues are maximized. Where the fight starts is deciding what the real shape of the Laffer Curve is. Conservatives (not all of GOP) argue that because "tax cuts always spur economic growth" the shape looks something like Chart 2 where revenue is maximum when tax rates are near zero. Everybody else thinks it looks more like Chart 1.
If fact, much research is being conducted to figure out what that "sweet spot" is (Chart 3). Strong conservative economists say it is as low as 17% while Keynesian economists think 70% is not too far off. The most recent studies put it somewhere between 45% and 65% with a few suggesting 70%.
Myths About GOP Claims About What Tax Cuts Provide
With that as background, let's move on to what Hanaur had to say. He starts off by saying:
"The rich are “job creators,” we’ve told you. The more money and incentives we wealthy few have to invest in creating jobs, the better the economy is for everybody—especially you.
That’s a lie.
There is is simply no empirical evidence nor plausible economic mechanism to support the claim that cutting top tax rates spurs economic growth."
Well, while I agree with the sentiment, saying "That's a lie" is a bit of an overstatement. First, there are empirical data and plausible economic mechanisms which will show that some of the marginal increase in income actually does go to "job creation", just not nearly as much as the Right would have you believe. What empirical studies have shown is that the rich spend only a small portion of any extra money on things that generate demand or new businesses. Take Chart 4, for example from a piece NPR did.
It shows about 68%, 63.7%, and 56.6% of Poor, Middle, and Rich class, respectively, spend money on things that increase demand. Much of what is spent on housing go to non-growth items such as rent, mortgage, and interest. Only 2.6%, 9.6%, and 15.9%, respectively, go into savings1, which can be tied to directly to "job creation". Further, the richer you are, the more you spend money that helps foreign nations rather than the American economy.
And in those two facts lies the lie Hanaur should have talked about. Simplistically speaking, at best only 15% of the tax savings the wealth receive will go to "creating jobs". The rhetoric from the Right would have you believe almost 100% of the tax savings would go to creating new jobs ... not going to happen, Bottom line, even though Hanaur's quote is an exaggeration, it is not much of one.
A comment about Demand. If the amount of savings that will go to the rich went the middle and poor classes, then there would be a substantial increase in demand2. This is unlike what would happen with the wealthy, there simply aren't enough of them to make a difference demand-wise since it is the Quantity of goods and services purchased, not their Price.
One last point, studies show that around 25% of the super-rich's (top .01%) wealth is parked in off-shore tax havens doing American economic growth no good.
1. Savings and cash in banks are the domestic sources for investing in new or expanding businesses. The other major source is foreign purchase of Treasury debt.
2. Maybe enough to increase growth even in an already growing economy. But even so, because we are currently at a full economy and a substantial increase in production is problematic, what increase there is will drive increased wages ... IF the tax savings went to the poor and middle classes.
Examples of Where Tax Cuts DON'T Spur Economic Growth
Hanaur provides several examples of why this bedrock conservative principle is wrong. He starts with:
- "When President George W. Bush slashed taxes, the economy ultimately collapsed. It wasn’t until after most of the Bush tax cuts expired during the Obama administration that the post-Great Recession recovery started to pick up steam—an ongoing recovery that, as uneven as it has been, has grown into one of the longest economic expansions in U.S. history
- "And then, of course, there’s Kansas.In 2012, Kansas Governor Sam Brownback famously embarked on what he called “a real live experiment,” pitting pure trickle-down theory against economic reality. Unfortunately for Kansans, reality won. Kansas has dramatically underperformed its neighboring states and the nation as a whole in economic growth and job creation since slashing taxes on individuals and corporations to as low as zero.
- "Compare that to California, which in 2012 elicited the usual apocalyptic warnings from trickle-downers by daring to raise its top income tax rate to a highest-in-the-nation 13.3 percent. By 2015, California had the fastest-growing economy in the nation. Kansas? Dead last.
- "When President Bill Clinton [and George H. W. Bush] hiked taxes, the economy boomed."
- He then cites a "Multi-decade statistical reviews by the Center on Budget and Policy Priorities, the nonpartisan Congressional Research Service, and the highly regarded Brookings Institution have all failed to find any negative correlation between top tax rates and growth.
- "And the same holds true of every other economic indicator the trickle-downers like to go on about: tax revenue growth, investment growth, employment growth, productivity growth, real median income growth. If they show any statistically significant correlation between top tax rates and growth, the slope is positive, suggesting that raising taxes on the rich is actually pro-growth.
- “The argument that income tax cuts raise growth is repeated so often that it is sometimes taken as gospel,” the Brookings authors conclude. “However, theory, evidence, and simulation studies tell a different and more complicated story.”
GDP GROWTH Previous 5 Yrs < Next 5 Yrs
So what can we tell from the data in Table 1? There were a total of eight changes in taxes1 from the Eisenhower to Obama administrations. There were three times taxes were increased on the rich, G. W. Bush, Clinton, and Obama. In each case both tax revenues and GDP got better. This puts a lie that raising taxes is always bad.
On the other hand, taxes were cut in the Eisenhower, Kennedy-Johnson, Reagan 1, Reagan 2, and W. Bush administrations. The results were mixed with revenues increasing twice (Kennedy-Johnson and Reagan 2), decreasing twice (Eisenhower and W. Bush), and no change with Reagan 1. Only with the Reagan 1 tax cut did GDP actually increase; in the other four cases GDP actually decreased2.
Taken all together, it is not clear how the GOP can make the case that their tax cut plan can ever generate enough economic growth to make up for the $3.1 trillion loss in tax revenue, let alone generate additional growth3,4.
1. There really are nine, but I combined the Kennedy and Johnson tax cuts because they were only a year apart.
2. There was actually a GDP increase the year after the Kennedy portion of the tax cut but disappeared after the Johnson cut taxes
3. Not discussed is how the economy can grow with a workforce that is basically fully employed and, if the GOP's immigration plans are realized, a shrinking population. The silver-lining in that scenario is that the increased demand, while probably not being met, will drive wage inflation.
4. Also not analysed is the value (really, the lack thereof) of a stimulus in a non-recessionary economy.
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© 2017 Scott Belford