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Trump's tax cut plan only pays for itself with growth in 'fairyland'

  • President Trump wants Congress to slash corporate taxes.
  • The administration insists the cuts will "pay for themselves" with faster economic growth.
  • Critics say that math only works in "fairyland."

President Donald Trump's call to slash business tax rates will no doubt win wide support in American corporate boardrooms.

But one of the main tenets of the plan — offsetting lower revenues with faster economic growth — is getting a cooler reception from critics of the plan.

That's because some believe the premise that cutting taxes across the board, without increasing the national debt, just doesn't add up.

Fulfilling a widely touted campaign promise, the Trump administration Wednesday announced the bare outlines of a plan to cut the top rate on corporate taxes from the current 35 percent to just 15 percent. The plan reportedly would also offer companies a special low tax rate on any profits stashed overseas when they bring that money back to the U.S.

For individuals, the Trump administration is proposing cutting the number of personal income tax rates from seven to just three brackets: 10 percent, 25 percent and 35 percent.

The plan also proposed increasing the standard deduction, effectively eliminating taxes on the first $24,000 of a couple's income. The estate tax and alternative minimum tax would also be eliminated, along with a 3.8 percent investment tax imposed under the Affordable Care Act.

National Economic Council Director Gary Cohn told reporters that "homeownership, charitable giving and retirement savings will be protected, but other tax benefits will be eliminated."

Those deductions include some of the most popular provisions of the tax code, because they allow households to cut their tax bills by writing off expenses like taxes paid to state and local governments.

But the proposal was short on details of just how the plan would make up for the shortfall created by lower rates.

Treasury Secretary Steve Mnuchin Wednesday repeated the administration's pledge that the proposal "will pay for itself" over time as the economy grows and the tax base widens. The theory is that, as lower taxes spur growth in the economy, the tax base will grow fast enough to make up for the shortfall from lowering tax rates.

It's an idea that's been around since the Reagan administration cut taxes in 1981. But there's little evidence that future growth makes up for the revenues lost when tax rates go down.

"This idea that growth can pay for these kinds of huge tax cuts is operating in fairyland," former Clinton administration budget director Leon Panetta told MSNBC on Wednesday. "That just doesn't work, so if you're going to do a tax cut, then show how you're paying for it."

With Congress already struggling to head off looming budget deficits, that assumption may be a tough sell, according to Jim O'Sullivan, chief U.S. economist at High Frequency Economics.

"While the administration can show tax cuts largely "paying for themselves" by simply changing economic assumptions, Congressional legislation is subject to stricter rules," he wrote in a recent note to clients.

So how will this plan affect my taxes?

No one knows. The plan is short on details, and Congress has yet to weigh in on where and how deeply taxes would be cut.

Trump has also promised to reduce taxes for the middle class, but the administration hasn't said how it plans to offset those cuts by eliminating specific deductions and other tax breaks. Without closing loopholes, the government would collect less money, federal budget deficits would get bigger and the national debt would continue to rise.

Trump administration officials insist that cutting taxes on individuals and businesses will spur growth, boost profits, create more jobs and wages — all of which gives the government more money to tax.

It sounds like a great idea. Will it work?

That's a multitrillion-dollar question. Mnuchin has conceded that, if you don't factor in faster economic growth – a process known as "dynamic scoring" – the math may not work.

The problem is that the strategy has been tried twice – most recently by President George W. Bush and earlier during the Reagan administration. In both cases, tax cuts were based on the premise that faster economic growth, along with higher profits and wages, would make up revenues lost from lower tax rates.

It didn't work, and budget deficits added trillions to the national debt.

On the other hand, after tax rates went up during the Clinton administration, federal tax receipts also went up and the national debt as a share of GDP went down.

But cutting taxes and letting companies keep more of their profits should allow them to investment more in their businesses. Isn't that a good thing?

In theory, sure. Reinvesting those profits helps spur more economic growth and creates jobs. The problem is that the theory didn't hold up after the last three major changes in tax policy.

Companies invested more of their profits after the Clinton tax increases of the 1990s than they did after the Reagan tax cuts in 1981 and the Bush tax cuts in 2001.

Trump has also said he plans to find ways to cut the federal budget. Why not just cut federal spending to make up for all these tax cuts?

That's another idea that sounds great on the campaign trail, but past presidents have found it very tough to pull off.

For one thing, massive cuts in federal spending would slow the economy, along with the growth of profits and wages that Trump's plan would need to make up for cutting tax rates.

But even if economic growth accelerates, cutting federal spending is a lot harder than it sounds

More than two-thirds of every federal dollar of tax revenue is considered "mandatory" spending, much of which is effectively off-limits. That includes Social Security, Medicare and interest on the national debt. (Trump has also proposed big increases in defense spending, offset with cuts in programs that are popular with both parties in Congress.)

For the past two decades, Congress and the White House have had only mixed success as they struggled with the growth of federal spending. The current strategy, the so-called sequester, placed caps on the growth of spending categories.

But those measures failed to address the surge in Treasury debt that followed the 2008 financial crisis, issued in part to prevent a deeper economic catastrophe.

Between 2007 and 2016, the national debt more than doubled as a share of GDP, to 77 percent from 35 percent, according to the Committee for a Responsible Federal Budget, a nonpartisan watchdog group.

That means Trump begins his administration with higher debt than any president since Harry Truman in 1945, when debt was 103 percent of GDP, according to the CRFB.

And if interest rates rise, the cost of rolling over all that debt also will go up.

That's why many observers are convinced that Congress will balk at any tax cut proposal that creates bigger budget deficits.

"Assuming we don't do anything about it, the (national) debt will double in the next few decades to 150 percent of our GDP," said Panetta. "Our economy can't sustain that."

Watch: Less taxes, more problems?