Andy Ellard counts himself among those who are fired up about US president Donald Trump’s tax overhaul — but not because the Texas-based manufacturer is expecting a big reduction in his own tax bills.
The general manager of Manda Machine Co, a small family-owned manufacturer making parts for flight simulators and gas turbines, says any tax benefits he receives directly will be too modest to affect his investment plans.
Nevertheless, as he picks his way between pieces of machining kit on his cramped shop floor in north-west Dallas, Mr Ellard predicts the big corporations that rank among his customers will see their tax bills plunge — prompting them to shift activity back to the US and ramp up spending on his products.
“I don’t want to be left out, but I don’t mind them getting tax cuts because they are going to bring stuff here,” he says. “It is not going to just sit in the bank, I promise you that.”
Whether Mr Ellard is right to be setting such store in the trickle-down effects of the reform goes to the heart of the biggest economic debate in Washington. Republicans are brandishing the tax bill, which could be voted on in the Senate as soon as November 30, as a game-changer that will create sustainable growth of at least 3 per cent.
The White House says the corporate tax cut alone could boost average wages by thousands of dollars a year as it galvanises investment and hiring by multinationals that have been hoarding profits overseas because of America’s high headline tax rate. Conservative groups have spent tens of millions of dollars on a pro-reform advertising blitz.
Yet Republican’s plans for a “people’s tax code”, which they say will be a boon for the middle class, are being savaged by many economists and earning lukewarm polling numbers. Independent analysis suggests the benefits will be skewed to the richest in society.
Meanwhile, repeated claims by Treasury secretary Steven Mnuchin that the cuts will more than pay for themselves have been widely lambasted, given his failure to offer any supporting analysis. Academic models including one run at the University of Pennsylvania’s Wharton School suggest the package will pile on trillions of additional dollars in public debt as tax revenue sinks, sapping positive growth effects over time.
“I think it is close to a wash,” says Alan Blinder, a former vice-chairman of the Federal Reserve board now at Princeton University — in other words, it will have little overall economic impact. “A wash is a very bad grade; this is being put forward by advocates as a way to begin a growth miracle.”
At the White House such claims are vehemently dismissed. While the tax package contains changes both to individual and business taxes, the provision Mr Trump appears most resolute on achieving is a cut in the top corporate tax rate to 20 per cent from 35 per cent.
Kevin Hassett, the chairman of the president’s Council of Economic Advisers, is a longtime advocate of corporate tax reform. He describes the regime as a “self-inflicted wound” that is chasing jobs overseas by deterring companies from investing in the US.
The level of gross domestic product could be 3-5 per cent higher over 10 years because of the corporate changes, Mr Hassett says in an interview. “In the long run, deficit reduction is extremely important. But in the short run, fixing this horrible international tax problem is essential if we are going to sustain the 3 per cent growth that we have at the moment,” he says.
At the heart of Mr Hassett’s analysis lies the argument that the burden of corporate tax lies heavily on ordinary Americans, which means that cutting the corporate rate will help them as well as shareholders. Last month he published research drawing on cross-country and cross-state statistical exercises claiming Americans will see an average wage gain of $4,000 to $9,000 a year as companies plough cash back into the US, investing in new capacity and bolstering productivity.
Mr Hassett’s wage figures have earned opprobrium from economists including Larry Summers, a former Treasury secretary under Bill Clinton, who say the predictions imply total wage gains of three to five times the magnitude of the tax revenue cut.
William Cline, an economist at the Peterson Institute for International Economics, says that there could well be a positive wage effect from the corporate cuts, but using a different model from Mr Hassett his research points to a wage uplift that is a fraction of the size.
To economists such as Mr Cline, the basic contention that lowering the corporate rate will be transformative is difficult to square with historical evidence. There was a large cut in the statutory corporate tax rate, from about 50 per cent in the 1960s and 1970s to about 35 per cent in 1988, but little response in the rate of business investment. The fruits of a tax “holiday” under George W Bush in 2004, aimed at encouraging companies to repatriate overseas profits, ended up being doled out to shareholders, according to 2009 research.
While tax cuts can deliver growth dividends in a deep recession, economists such as Mr Blinder say the US is at full employment with above-trend growth, meaning the Federal Reserve may rein in any tax stimulus with tighter monetary policy.
Alan Auerbach, a Berkeley economist who favoured a now-ditched border tax that was pursued by the Republicans earlier this year, says he expects some positive growth effects from the business tax reforms — especially the lowering of the corporate tax rate.
“On the other side there is going to be a pretty big increase in the deficit, which is going to counteract the beneficial effects,” he warns. “All in all I would not predict a very large increase in economic activity looking 10 years down the road.”
Both Republicans and Democrats believe corporate tax reform is long overdue given America’s system of taxing companies on global income which, coupled with high rates, has encouraged multinationals to stash upward of $2tn in earnings overseas. The need to simplify the personal tax system, with its myriad deductions and interplay between federal and local systems, is also widely endorsed.
But unlike the previous big tax reform effort in 1986, the Republicans are seeking to introduce the changes without relying on any Democratic support. Their embrace of reforms, including an estate tax repeal that will benefit a few thousand wealthy families, has prompted Democrats to oppose the bill.
Standing behind the Republicans are big corporate lobbying organisations and dozens of conservative groups, some supported by business leaders including the billionaire Koch Brothers. Large sums are being spent on advertising campaigns in key districts and on “robocalls” to voters in states with wavering lawmakers.
For example, the American Action Network, a non-profit group aligned to the House Republican leadership, has been spending in the region of $20m on radio and TV ads, phone campaigns and other initiatives across scores of congressional districts. It is touting the Republican tax package as a boon for ordinary voters, calling its effort the “middle-class growth initiative”.
The tax bill
50%
Corporate tax rate in 1960s, which fell to 35% in 1988 and could drop to 20% under the new legislation
$4,000
Minimum gain in average wages the White House thinks tax bill will cause
$136bn
Potential cut in federal spending in 2018 as a result of tax bill
Analysis of the distributional effects of the changes paints a less sunny picture. The Tax Policy Center, a think-tank, has found that more than 60 per cent of the benefits of tax reform would accrue to the top 1 per cent of earners in 2027. By that year, taxes would rise modestly for the lowest-income group, change little for middle-income groups, and decrease for higher-income groups.
This is partly driven by the decision to make proposed individual tax cuts expire over a decade to comply with deficit-limiting rules in the Senate — even as the corporate tax cuts stay in place. The fact that companies are getting a permanent cut while households’ reductions are temporary has led to inevitable protests by Democrats.
The White House insists the cuts will be extended by a future Congress. But this idea worries fiscally conservative GOP senators including Jeff Flake of Arizona and Bob Corker of Tennessee, and there is no predicting what future lawmakers will end up doing.
“I don’t feel that is a tax cut for the middle class — it is just for the rich,” says Roy Padilla, a dishwasher who works the graveyard shift in one of the big resorts in Las Vegas.
The union member says the package is raising eyebrows among fellow workers, who fear they will not benefit. They are not alone. Just 16 per cent of Americans polled by Connecticut’s Quinnipiac University in mid-November say they expect the GOP plan to cut their taxes. Some 61 per cent predicted the wealthy would mainly benefit.
Mr Padilla’s worry is not just the equity of the tax changes. He also fears Congress will cut medical spending or educational funding as tax revenues fall, affecting his four children. There is some justification for that prediction.
Conservative Republicans have long seen tax cuts as a way of forcing public sector retrenchment, and the White House has vowed to focus on welfare spending once tax reform is completed.
Under congressional “pay-as-you-go” rules the White House’s Office of Management and Budget will be forced to offset increases in the deficit caused by the tax reductions by cutting $136bn of spending in 2018 unless Congress legislates to avoid this. Among the possible consequences are an automatic $25bn cut to Medicare, the health programme for the elderly.
To the backers of reform, gloomy distributional tables and predictions about public spending are missing the bigger picture. The US tax code is in dire need of reform, they say, and if the proposals are passed they will open up the opportunity for a large boost to growth, which will benefit all Americans.
Trent Lott, the former Republican Senate majority leader now at law firm Squire Patton Boggs, says: “I am a believer that if you get the corporate rate where it should be and cut individual rates and make sure small business is included, we will have an explosion of growth. It happened after Kennedy, Reagan and Clinton.”
Yet even among businesses, there are many doubts about the impact of the tax plan. Casey Jones, the founder of Fair Winds Brewing, a Virginia beer maker, says there are some measures in the tax package that would be helpful, in particular an improvement in the excise tax regime targeted at small businesses.
But he says many business owners’ personal finances will be hit by a less generous mortgage interest deduction against taxable income, which is a key measure on the individual side of the reforms. And he is sceptical that big companies will respond to lower rates with a blitz of investment.
“Trickle down economics doesn’t work,” he says. “Whatever happens to tax reform is not going to result in a significant investment in the company. It tends to result in significant distributions to shareholders.”
Morning in America: bill differs from Reagan reform
Donald Trump has lavished praise on Ronald Reagan’s landmark 1986 tax reform, echoing the former president’s “morning in America” rhetoric, but the package currently being rushed through Congress is very different from the one passed 30 years ago.
The 1986 package was a bipartisan effort, winning over both a Republican-controlled Senate and Democratic House. This was possible because at its heart the reforms were focused on reducing tax rates on individuals while stripping away some of the deductions and exemptions that favoured certain groups.
This time round, big companies are emerging as the key beneficiaries of the reforms, with the impact on individual taxpayers far more contested. “It was a much more populist bill than this one,” says Jeffrey Birnbaum, one of the authors of Showdown at Gucci Gulch, a book on the 1986 bill that congressional aides have been poring over. “In 1986 it was a more direct and immediate tax cut for individuals.”
The differences do not stop there. Unlike the current legislation, the 1986 reforms were budget neutral, as lawmakers worked with the White House over two years to simplify the convoluted tax code without creating a bigger federal deficit. The debate about reform was far more open, whereas this time lawmakers decided to disclose the details as late in the day as possible, as they attempt to minimise the risk of the cuts being derailed by various interest groups.
Critically, the role of the White House is very different today. The Trump administration has put forward only skeletal tax plans of its own, leaving most of the work to Congress. And whereas Reagan was the driving force in 1986, Mr Trump is a more divisive figure, whose public attacks on senators on his own side have added to the uncertainty.
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