Tax policymaking entails a series of trade-offs, David M. Smick says
Smick: If Trump delivers on tax reform, he'll have to make some hard political choices
Editor’s Note: David M. Smick is chairman and CEO of the macroeconomic advisory firm Johnson Smick International and founder and editor of the International Economy magazine. His new book is “The Great Equalizer: How Main Street Capitalism Can Create an Economy for Everyone.” The opinions expressed in this commentary are his.
Facing fierce criticism from the right on fiscal policy, President Donald Trump has developed a new sense of urgency. In an interview last weekend with Fox’s Bill O’Reilly, when asked if Americans should expect a tax cut this year, instead of saying something along the lines of “yes, absolutely,” Trump offered the more restrained, “I think so … before the end of the year. I would like to say yes.”
Such an expression of caution is unusual for the 45th President. Yet Thursday, Trump suddenly shifted gears, promising to announce a “phenomenal” tax reform proposal in an amazingly short two to three weeks.
Reforming the tax code is likely to be far more politically complicated than the Trump officials, most of whom are new to Washington, think. As a congressional staff aide and later an outside adviser, I worked on both the 1981 and 1986 tax reform packages.
The process of seeking a consensus was difficult and time-consuming. In the case of the 1986 tax reform, it took years to resolve some serious differences. Trump will face a similar challenge in a much more compressed time period. Announcements are easy to make. Actually enacting tax reform is a lot more difficult.
The details of the President’s plan have yet to be announced, but a rough outline exists. The outline largely reflects the House Republican tax reform plan. And the answer to two questions will likely determine the success of the overall effort:
First, will the Senate (and perhaps even some House Republicans) kill the House’s proposal for a border adjustment tax (which produces an estimated $1.4 trillion in new revenue over 10 years, the amount roughly needed for Trump’s infrastructure spending and military modernization)?
The new proposed border-adjusted tax system would place a 20% tax on imports while eliminating the corporate income tax. It is being heavily attacked by US importers, Walmart, Koch Industries and foreign governments. Proponents argue that US companies, by not having to pay taxes on exports, would for the first time face a level playing field in tax policy relative to their global competition.
Second, will the Senate accept the House’s use of “dynamic scoring” in determining the budget implications of tax reform? Dynamic scoring assumes tax incentives have some effect in creating greater tax revenue. Critics charge that dynamic scoring is “funny math.” Proponents use the analogy of a small business. “If you expand your sales budget by $100,000, you wouldn’t expect sales revenues to stay the same,” they argue.
Here’s why these questions are relevant: If dynamic scoring is accepted, tax reform will include the immediate expensing for tax purposes of all capital investment, a huge stimulus for business expansion. As one congressional leader told me, “If there is no dynamic scoring, expensing is out,” because the static revenue loss (on paper) as a result of the stimulus would not comply with the 10-year budget restrictions previously set by Congress.
By the same token, if there is no border adjustment tax, the Trump fiscal stimulus is likely to be significantly smaller than originally envisioned. US tax policy will change, but there may be nothing “phenomenal” about the final result.
Making tax policymaking entails a series of trade-offs. If the choice is between a border adjustment tax versus Trump’s reckless call for 35% or higher tariffs aimed at US trade competitors, the choice is clear.
Tariffs would risk a global trade war and almost certain worldwide recession. The border adjustment alternative would likely be consistent with the rules of the World Trade Organization and would not lead necessarily to trade retaliation. The US corporate tax system would not be dissimilar to the value-added tax systems used elsewhere in the world to the disadvantage of American companies.
But here’s the ultimate question: Is the President’s call for tariffs the opening bid in an elaborate effort to strike a deal on a border adjustment tax he wanted all along?
In other words, by threatening the world with tariffs, does the border adjustment tax (and its $1.4 trillion in new revenue) become the reasonable and safe alternative? Or is the new President not that clever? When all is said and done, one thing is certain about tax policy: All policy changes produce unintended economic and political consequences. That’s why enacting a border adjustment tax is hardly a sure thing.
Finally, there is the issue of Trump’s promise of individual tax rate reduction. Some of the administration’s economic advisers have suggested the personal tax reductions be separated from the corporate tax stimulus, with the personal tax code to be addressed at a later time.
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Here’s the problem: More than 80% of businesses in the United States use so-called “pass-throughs” to pay their taxes – proprietorships, partnerships, Subchapter S organizations that all pay their taxes using the personal income tax schedules. Unless these firms are part of the corporate tax reform plan, small businesses and startups, which are already at a disadvantage relative to large corporations because of the complexity of the tax code, will fall further behind.
The upshot is that many Democrats in Congress are open to supporting a plan that reforms the inefficient corporate tax system. Few Democrats will support a plan for individual tax rate reduction. Here’s the problem: Can a President who won by promising support for the Rust Belt’s “forgotten man” really agree to a plan that delays tax rate cuts for the middle class and pushes fiscal stimulus for the corporate class?