Taxes, Growth, and the Wrong Side of the Laffer Curve

By May 11, 2017Blog

On April 26th, 2017, President Trump’s White House released the first draft of the highly anticipated tax reform package promised during the 2016 election. Though only a single page, the document contained a number of major proposals, and is easily one of the most important policy measures to come out of the president’s much-vaunted and completely arbitrary “first 100 days” in office. Unsurprisingly, it has also proven extremely divisive.

Key to the plan are a number of important changes to how individuals would pay their taxes. A doubling of the standard deduction would simplify tax filings for millions of Americans, while the corresponding elimination of a number of itemized deductions would reduce the options of those not using the standard deduction. The proposed repeal of both the estate tax and alternative minimum tax would also reduce the burden and compliance costs for many—primarily wealthy—taxpayers.

The real kicker, though, is the recommendation to overhaul America’s corporate tax structure. Under President Trump’s plan, the corporate income tax rate would slashed from 35 percent to just 15 percent. It is primarily this measure that has won the simple, one-page outline praise from major business advocacy organizations. Such proponents contend that the lower rate will spur economic growth and encourage domestic businesses to repatriate assets, investments, and operations to U.S. soil.

But not everyone is so convinced. Fellow business moguls and billionaires Bill Gates and Warren Buffet were quick to voice their skepticism about the plan’s promised benefits, and it has been widely criticized as a thinly-veiled handout to America’s wealthiest citizens. Still others fret that, if implemented, the reform package will further exacerbate the deficit and add to the debt. 

On this last matter, at least, the critics are almost certainly correct. Yes, the United States has one of the highest statutory corporate tax rates in the world, and yes, reducing taxes will spur at least some economic growth. With that said, relying on that growth to fully offset the decline in government inlays is a dubious proposition at best. The theoretical underpinnings of these sentiments are certainly compelling—enough so that they get their own Wikipedia page—but recent real-world experiments have all shown the U.S. to be entrenched thoroughly on the left-hand side of the Laffer curve.

That doesn’t mean proponents of the plan won’t argue otherwise; Treasury Secretary Steven Mnuchin already is. Now, it bears repeating that the Trump tax plan definitely has its upsides. Many ordinary Americans and businesses will likely reap significant benefits if the plan is approved by Congress in anything resembling its current form. But, absent major cuts in Federal outlays or a rate of economic growth bordering on miraculous, the side effect will be an even larger deficit. This is not a recipe for long-term fiscal success. It’s also not a recipe that’s particularly novel to Washington, D.C. 

If you found our thoughts on the new tax plan interesting, take a look at how AngelouEconomics helped the Texas Association of Realtors determine the economic impact of legislation pertaining to their work:

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