U.S. Markets closed

The dirty secret of tax reform: It’s all about cutting business taxes

Rick Newman
Senior Columnist

A battle is raging among tax geeks that ordinary voters will soon have to weigh in on. Is cutting taxes on businesses and corporations good for the middle class? Or is it just a windfall for CEOs and shareholders?

President Donald Trump’s tax outline calls for cutting the corporate tax rate to 20% from 35%, which just about everybody agrees would boost corporate profits and push stock prices up. But then what? Would companies invest more, hire more and pay more? Or would extra capital remain concentrated in the hands of the wealthy, with little net effect on economic growth?

There’s data supporting each view. The White House’s Council of Economic Advisers published a recent study arguing that Trump’s cut in the corporate rate would boost the typical family’s take-home pay by at least $4,000 per year. Companies would invest and spend more in the United States, boosting demand for goods and services and pushing wages up. An independent analysis by tax experts at Boston University and MIT generally supports that view, finding that the cuts would boost wages by 4% to 7%, after inflation.

But Larry Summers, former Treasury secretary in the Clinton administration, blasted the CEA prediction as “absurd” and “unprecedented.” And recent analysis by the Tax Policy Center found that the Trump plan would boost after-tax income for the top 1% of earners by 8.5%, while those in the middle would see a gain of just 1.2%. That study also found the Trump plan would add $2.4 trillion to the $20 trillion national debt.

No truth czar is going to materialize to settle this debate by the time a tax bill lands on Trump’s desk, probably sometime in the spring of 2018. So, the question of whether ordinary people would benefit from a cut in business taxes is going to be a matter of persuasion and belief.

Individuals’ tax breaks

The final tax bill will almost certainly include cuts in tax rates for individuals, as well, since it’s not politically feasible to cut taxes for businesses without also cutting them for ordinary folks. But individual tax cuts aren’t expected to help the economy much, if at all, as surprising as that may sound. The Boston University/MIT study finds that cutting personal rates actually generates “lower long-run economic welfare” because it pushes federal deficits upward. So even if individual cuts are in the bill, it’s the change in the corporate rate that might produce the largest economic benefit.

If other countries had corporate tax rates similar to the U.S. rate, none of this would be an issue. But developed countries in Europe and other parts of the world have been cutting their corporate rates, to attract multinational corporations that can do business anywhere, leaving the United States an odd man out. The U.S. rate of 35% is now the highest among developed countries, higher even than in France. Most U.S. companies don’t pay that rate, thanks to deductions, credits and other loopholes. But the high marginal rate still affects where companies do business and invest.

The divergence in corporate rates around the world has left the business side of the U.S. tax code in greater need of repair than the individual side. For individuals, the tax burden in the United States is lower than average for advance economies, with a typical family with two kids owing about 14% of gross income in federal taxes, according to the OECD. That’s not terrible, and the individual tax code doesn’t exactly create incentives for Americans to move to other countries, the way the business side of the tax code does.

So as the Republican tax reform effort develops, tax cuts for individuals will largely serve as window dressing for lower business rates. That might be okay in the end, but we won’t know for years and the arguments will probably continue no matter what the outcome.

Confidential tip line: rickjnewman@yahoo.com. Encrypted communication available.

Read more:

Rick Newman is the author of four books, including Rebounders: How Winners Pivot from Setback to Success. Follow him on Twitter: @rickjnewman