The latest set of Republican tax proposals faces significant opposition, but just enough of them should survive to lift growth a bit in 2018.
To great fanfare, the Republican Party released its latest set of tax proposals. Once again, the proposals lacked all sorts of details, making it hard to assess. If you’re optimistic, you can draw some comfort from the different groups and caucuses of Republicans who seem to be on board. If you’re pessimistic, you can point to the lack of details, which gives the whole document the air of “fuzzy math.”
The numbers game
The key issues we have written about before remain unaddressed. If you want to cut taxation on some or all taxpayers, you either have to cut spending to match the lower revenue, allow the deficit to grow, or raise taxes on some taxpayers (or some combination of the three). That’s not difficult economics. It’s just arithmetic. Spending is extremely hard to cut; indeed, many Republicans even want to increase spending on defense. However, allowing the deficit to grow is a hard sell to many key players in the debate. Admittedly, some of them have signaled a willingness to allow the deficit to rise in the short run as long as they can claim, with some degree of plausibility, that economic growth will rise and allow the deficit to close later.
The political calculation
Rather than cut spending, increasing some taxes in order to reduce others is a more popular idea for two reasons. The first is raw politics: If you can raise taxes on your political opponents in order to cut them on your supporters, why wouldn’t you? The second reason is because it might permit a more efficient, growth-friendly tax system. The latter reason inspired the initial run at tax reform by House Republicans, when they proposed the border adjustment tax (BAT) as a way to tilt incentives away from consumption and toward production. It has since been abandoned, but the saga of the BAT illustrates two points. The first point is that there is desire and willingness on the part of at least some senior Republicans to improve the efficiency of the tax code and raise revenue on some sectors to finance cuts elsewhere.
The second point is that, in a Madisonian political system like the United States (one that reflects the ideas of James Madison, a framer of the U.S. constitution), holders of privileges have many opportunities to defend their privileges. The BAT ran into a buzz saw of opposition, and Republican leadership seemed surprised. The latest set of proposals includes lower tax rates on the corporate sector and wealthier households that would be paid for in part by allowing the deficit to rise and in part by raising taxes on less-than-very-wealthy households. This will happen through a rationalization of tax allowances and deductions. Already it’s clear that Madison is working his magic as the beneficiaries of the existing set of deductions mobilize and as opposition builds to large increases in the deficit.
The latest set of proposals includes lower tax rates on the corporate sector and wealthier households that would be paid for in part by allowing the deficit to rise and in part by raising taxes on less-than-very-wealthy households.
My guess is that this opposition to change is too strong to overcome, and Republicans will end up having to live with modest tax cuts and precious little in the way of reform. My assessment of the Washington mood is that this — a smaller plan — will be able to pass. It will have a modest, positive impact on growth that may be visible as soon as the second half of next year, primarily through the incentives to corporate investment that are likely to survive political pressure, in our view. Indeed, a handful of conservative Democrats have signaled they are willing to support some rationalization of business taxation.
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Against a backdrop of continued political challenges around the world, the global economy continues to do well and markets seem more encouraged by the growth than they are disconcerted by the political volatility.