The voices of Tax Policy Center's researchers and staff
On April 11, I testified before the congressional Joint Economic Committee on whether the Tax Cuts and Jobs Act (TCJA) will help "Unleash America’s Economic Potential.” I find that Congress is conducting an interesting experiment by enacting a major economic stimulus at a time of full-employment.
To evaluate the new law, consider the four basic tenets of good tax policy:
- Revenue adequacy – Tax systems should raise enough revenue to meet the current and future obligations of government.
- Efficiency – Tax systems should raise that revenue in a way that impedes as little as possible the allocation of resources, underlying economic behavior, and economic growth prospects.
- Equity – Tax systems should raise revenue in ways that citizens perceive to be fair. Economists generally talk about two aspects of fairness:
- Horizontal equity – Treating taxpayers with similar incomes in a similar manner.
- Vertical equity – Assessing taxes based on ability to pay, which usually is characterized as a progressive tax system, one where individuals’ tax liabilities as a share of income tend to increase with income.
- Simplicity – Tax systems should permit individuals to understand the tax consequences of their economic behavior. Tax laws should be clear, comprehensible, and predictable.
In the real world, all these goals involve tradeoffs. But keeping these aims in mind makes it possible to evaluate changes in tax levels on some objective basis.
How does the TCJA measure up against these goals?
- Revenue effects – The TCJA is a large tax cut in the short term, which will provide economic stimulus. The law will cut taxes by about $135 billion this fiscal year and roughly twice that much next fiscal year.
- Distributional effects – The benefits of the TCJA are tilted toward higher income taxpayers. The 20 percent of the income distribution with the lowest incomes will benefit by about $60 per year on average, or about 0.4 percent of average after-tax income, according to the Tax Policy Center. By contrast, taxpayers in the top 20 percent of the income distribution will receive an average tax cut of more than $7,600 per year for or 2.2 percent of average after-tax income.
- Temporary tax cuts – Most individual income tax provision changes are temporary. Important investment provisions such as bonus depreciation also are temporary. In contrast, the corporate income tax provisions, including the rate reductions and the new system for taxing multinational firms, are permanent.
- Multiple tax systems – The law establishes a different tax system for certain income from pass-through entities, such as sole proprietorships, partnerships, or subchapter-S corporations. This means that income of owners of these businesses will be taxed differently than other types of employment income, violating the principle of horizontal equity and simplicity.
How will the law affect economic growth and jobs? Conventional analysis suggests these effects are likely to be modest because:
- The economy is near full employment now, so the economic stimulus from the tax cuts is likely to be limited;
- The primary investment incentives are temporary and therefore will have limited effects;
- The longer-term costs of higher interest rates driven by larger budget deficits will eventually discourage investment.
The Tax Policy Center, the Penn Wharton Budget Model, and the Congressional Joint Committee on Taxation (and the Congressional Budget Office) all come to a similar conclusion: The economic effects of the TCJA are positive in the short run but will dissipate over subsequent years.
Impact on Fiscal Position of the US
Over the last 60 years or so, federal receipts have tended to fluctuate in a range of 15-20 percent of Gross Domestic Product (GDP). Tax legislation, economic booms, and economic downturns have all occurred over this timeframe, but receipts as a share of the economy have stayed in this relatively narrow range. During this period, the federal budget was balanced just twice.
The most recent period was in the late 1990s/early 2000s, when federal receipts were right around 20 percent of GDP. Given demographic trends—retiring baby boomers, relatively low birth rates, and longer life spans—we should expect that revenue will have to at least reach those levels in the future to bring the federal budget into balance. But the TCJA goes in the opposite direction and reduces revenue as a share of the economy.
Thus, the TCJA is part of a large fiscal experiment. It provides a big fiscal stimulus when the economy is near full employment and it creates a number of investment incentives at a time when companies have been accumulating cash, indicating they have seen limited opportunities for profitable investments. But, proponents of the Act say that the law will lead to increased US investment that will in turn increase the productivity of US workers and increase wages.
It is too early to tell if all these linked relationships will occur. The outcomes are still months and years away, given investment planning horizons.
So the jury is out on the effects of the Tax Cuts and Jobs Act, but given the structure of the Act, with numerous parts scheduled to increase, phase-in, or phase-out, Congress will have many opportunities to evaluate the Act and make any necessary changes.
Posts and Comments are solely the opinion of the author and not that of the Tax Policy Center, Urban Institute, or Brookings Institution.