The GOP tax plan isn't even a good try at trickle-down economics

  • Top economic adviser Gary Cohn says the GOP tax plan going to have “trickle-down” benefits to middle-class Americans.
  • But even if you were trying to design a trickle-down plan, this one fails.

“The most excited group out there are big CEOs, about our tax plan,” says ex-Goldman Sachs President Gary Cohn, who runs the National Economic Council in the Trump White House, in an interview with CNBC’s John Harwood.

Of course they’re excited: The plan offers big tax cuts on business profits. But Cohn says regular people should be excited about the plan, too, because the benefits from business tax cuts will “trickle down” to them.

Cohn doesn’t seem to realise that “trickle down” has become a pejorative. It’s a term for a tax plan that’s supposed to produce benefits for the middle class that never materialise.

But even if you were trying to design a trickle-down plan — one that targets its business tax cuts according to supply-side theories of how to grow the economy and boost wages — the Republican tax plan fails.

These business tax cuts are poorly targeted. They are not sufficiently focused on encouraging new business investments.

Many of the business tax cuts in the Republican plan are simply windfalls for people who made business investments in the past — and even if investors are very responsive to incentives, they can’t respond to the bill by investing more in businesses and creating more jobs in the past.

Three kinds of business tax cuts

There are three big ways the bill cuts taxes on businesses. Here they are ranked, from most likely to least likely to grow the economy and “trickle down” as more jobs and higher wages.

  • Favourable treatment for new business investments. The House plan would allow businesses, for a few years, to immediately “expense” capital investments. That means, if they buy a new piece of durable machinery, they could deduct the purchase price immediately in the first year, instead of spreading it out over many years. This is a tax cut narrowly targeted at new investments — you only get a tax cut if you grow your business — and so it’s the kind of business tax cut most likely to improve the economy and create jobs. But this provision only lasts a few years, because it’s expensive and Republicans have other priorities.
  • Lower tax rates on business profits. The plan would reduce the tax rate on corporate businesses (from 35% to 20%) and create a new preferential tax rate for non-corporate businesses. At the margin, this may encourage new business investments. But it also sharply reduces taxes on the returns from business investments that were made in the past. That’s nice for you if you own a company — or stock in a company. But lower taxes on investments you already made don’t create jobs.
  • Deemed repatriation of overseas profits. This is the provision about “cash held overseas” by American companies that have accrued foreign profits. The bill would obligate the companies to bring these profits “home” and allow them to pay tax on them at a much reduced rate. Cohn argues this provision would make new capital available to invest in the United States, but he’s wrong. As I wrote a few weeks ago, “cash held overseas” is neither cash nor overseas. Apple’s “overseas cash,” for example, consists mostly of corporate bonds, which means Apple’s accrued profits have already been loaned to other companies for the purpose of business investment — these funds are already available for job creation. Repatriation neither lowers the cost of capital for businesses nor increases their expected after-tax return on future investments, so there’s no reason to expect it to cause companies to invest more, grow the economy, or raise wages. It is a one-time tax cut on business profits earned in the past, which means it will flow entirely to owners of capital. None of it can be expected to trickle down. Sad!

Another problem is that the Republican tax plan would significantly grow the national debt. This can be expected to produce a negative trickle-down effect, as higher government debt leads to higher interest rates, lower business investment, and higher future tax rates — possibly on the middle class.

The sad thing about the “trickle down” argument is that it’s not entirely wrong. Business taxes do affect investment; workers likely do bear a portion of the economic burden of the corporate income tax (though the size of that portion is hotly debated among economists); the right kind of business tax cuts really can grow the economy and benefit workers, especially as part of a plan that doesn’t grow the deficit.

But the key theme in the design of the Republican tax bill is that the business tax cuts are designed to benefit owners of capital first, with workers as an afterthought.

Republican officeholders have been talking surprisingly openly about how angry their major political donors will be if they don’t pass this tax cut package. That makes sense, since the donors would benefit directly from these tax cuts. They don’t need to worry about whether they will really trickle down.

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