There appears to be a major conflict between President Trump and the House GOP plan for tax reform. The conflict is due to the President’s instincts for favoring tax cuts and his concern over the unintended consequences from a fundamental change in tax policy.
During the campaign, the President proposed cutting taxes by roughly $1 trillion a year, $10 trillion over the next decade. His instincts on taxes are correct. Every successful tax cut in US history had one thing in common—sharply reduced tax burdens without major offsetting tax increases.
The current GOP tax plan extolls the many virtues from tax cuts. Unfortunately, it uses none of the successful plans as a model. Instead, its model is the Tax Reform Act of 1986, which the House Plan claims “…laid the foundation for decades of American job growth.”
This isn’t true. While the 1986 tax act included many positive tax cuts, it was also designed to be revenue neutral. This means any revenue the government might lose from lower tax rates has to be replaced by offsetting tax increases.
To offset the expected loss in revenue, the 1986 tax reform raised a number of other taxes. President Trump knows from first-hand experience how these other taxes laid the groundwork for a collapse in real estate prices, the failure of over 1,000 banks and a recession.
Similar to the 1986 reform, the current GOP plan “...envisions tax reform that is revenue neutral.” While the new plan allows for a modest increase in projected revenue due to faster growth, the increase is insufficient to make up for a projected shortfall in revenue. Hence, the House Plan involves over $5 trillion in tax increases over the next decade.
The most potentially damaging of these increases comes from a major restructuring in how profits are determined. The plan involves a so-called border tax, where profits are taxed based on where companies sell their goods.
The House plan for a border tax would significantly harm certain companies. Companies where imports make up a large percentage of their costs are adversely affected since they would not be allowed to deduct the cost of imports in calculating profits.
The plan would significantly benefit companies with large exports, since revenue from exports would not be counted in calculating profits. On balance, the border tax does more harm than good since the US imports far more than it exports.
The Tax Foundation estimates revenue from the border tax would amount to $1 trillion over 10 years. This type of major change in the calculation of profits threatens to disrupt the supply-chain responsible for all production. President Trump’s initial instinct to label the destination tax as “too complicated” is correct.
Recent comments by White House Press Secretary Sean Spicer suggested the US could impose a 20% tax on Mexican goods. Since this is similar to how imports would be affected by the border tax, newspaper accounts suggest the President might be rethinking his initial opposition to the border tax.
Five trillion dollars in new taxes, particularly the border adjustment tax, creates the potential to offset many of the benefits from the planned tax cuts.
President Trump was one of the few people able to identify the flaw in the 1986 tax act. This time, his instincts are to go for a large tax cuts, combined with cuts in government spending. For the past century, this has been the successful policy combination for restoring growth following periods of economic stagnation.
One early indication of Trump’s success in kick-starting the economy will be his inclination to oppose the disruptive effects from the various tax increases in the GOP plan. The first place to start is with dropping the ill-conceived border tax.