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The weird theory that turns Trump's tax cuts for the rich into a middle-class benefit

U.S. National Economic Director Gary Cohn (L) and Treasury Secretary Steven Mnuchin end their breifing after unveiling the Trump administration's tax reform proposal in the White House briefing room in Washington, U.S, April 26, 2017.
Kevin Lamarque | Reuters
U.S. National Economic Director Gary Cohn (L) and Treasury Secretary Steven Mnuchin end their breifing after unveiling the Trump administration's tax reform proposal in the White House briefing room in Washington, U.S, April 26, 2017.

President Trump's tax plan, or what we know about it anyway, is a bonanza for rich people. But the administration is still insisting, against all evidence, that it's a middle-class tax cut.

"This is a middle-class tax bill," Gary Cohn, Trump's chief economic adviser, told CBS This Morning. "We're eliminating the deductions that were added to the tax legislation over the years to favor the wealthy. The wealthy have deductions. Middle-income people and lower-income people don't have deductions."

Steve Mnuchin, the Treasury secretary, told Good Morning America the same. He refused to make any promises, but said his "No. 1 objective" is to make sure no one in the middle class pays more, and that another "objective" is making sure there are no absolute tax cuts for the wealthy.

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The idea that cutting deductions will make the plan better for the middle class is pure nonsense. There just aren't enough deductions in the tax code to make Trump's plan anything other than a giveaway to the wealthy.

Trump would hugely cut the corporate tax (a giveaway to rich shareholders). His plan slashes the top income tax rate for high earners from 39.6 percent to 35 percent. It gets rid of taxes that overwhelmingly apply to the wealthy — Obama's 3.8 percent investment surtax, the alternative minimum tax, and the estate tax. And it would set a top rate of 15 percent for the overwhelmingly rich owners of "pass-through" companies, compared with today's 39.6 percent. Mitt Romney's tax plan in 2012 had many fewer cuts, and researchers still found it was mathematically impossible to remove enough deductions to make it not a net cut for the rich.

But the argument that Trump's plan is actually a cut for middle-class people does have some research behind it — even if the idea is still far outside the mainstream of economics. The chief proponent of the idea that cutting corporate taxes helps the middle class is economist Kevin Hassett, whom Trump has picked as chair of the Council of Economic Advisers.

How Republicans could claim their corporate tax cuts are actually for workers

Like any self-respecting conservative economist, Hassett is passionate about cutting the corporate income tax. But his arguments on this score are slightly different from the typical concerns. Usually economists who want to cut corporate taxes argue that the US's rate is too high relative to other countries, or that the US tax code is out of step with international practice, or just that corporate taxes discourage investment.

Hassett's main argument, made in a series of papers written with his American Enterprise Institute colleague Aparna Mathur, is instead that corporate taxes strongly suppress wages, and that cutting them will rapidly raise the living standards of American workers.

Money that corporations earn goes, roughly speaking, to two groups: the people who own the company (capital) and the people who work for the company (labor). So the money for the tax can be raised either by paying out less money to capital owners or by reducing wages for workers.

Who actually pays the tax has huge implications for how progressive corporate taxation is. The more it's paid by capital, the more progressive it is and the less harmful it is to the middle class; the more it's paid by labor — or, at least, labor apart from executives like the CEO — the worse a deal it is for average workers.

Most modelers estimate that roughly 80 percent of the tax is paid by capital, and 20 percent by labor. Hassett thinks this is all wrong. In an influential 2006 paper analyzing data in 72 countries across 22 years, he and Mathur estimated that a "1 percent increase in corporate tax rates is associated with nearly a 1 percent drop in wage rates." A second paper in 2010found a slightly smaller effect (a 0.5 to 0.6 percent decrease in wage rates per 1 percent increase in corporate tax rates) but still concluded that labor was ultimately paying the tax.

That suggests that cutting corporate taxes would be a very easy way to raise wages for ordinary workers. Hassett has also gone a step further and, with his AEI colleague Alex Brill, argued that cutting the corporate income tax could raise economic growth enough to actually increase revenue: a Laffer effect. They conclude, based on a data set covering rich developed countries from 1980 to 2005, that the revenue-maximizing corporate tax rate is about 26 percent, significantly below the US rate.

All of this is very useful for the Trump administration's coming campaign to pass massive corporate tax cuts.

Most economists think the rich pay corporate taxes

But while Hassett is a widely respected economist, his work on this falls way outside the mainstream on this issue. Most other models find that capital, not labor, pays the bulk of corporate taxes. The Treasury Department puts the capital-labor split at 82-18, the Tax Policy Center at 80-20, the Congressional Budget Office at 75-25. Before relatively recently, it was standard practice to assume that capital paid the whole tax, and some observers argue that remains the correct approach, given recent empirical research showing that shareholders tend to be the exclusive beneficiaries of cuts in taxes affecting corporations.

And plenty economists and tax researchers have argued that Hassett's results in particular are implausible, and reach some absurd conclusions. Jane Gravelle and Thomas Hungerford at the Congressional Research Service noted that the initial Hassett-Mathur study predicted a $1 increase in the corporate tax would reduce wages by between $22 and $26. Their 2010 follow-up predicted a wage loss of $13 per for every additional dollar paid in corporate taxes. But it's very strange to imagine a corporation responding to an increase in costs like that. The implication is that corporations could have cut wages significantly before the tax hike without negative consequences and simply didn't.

A more recent survey of the empirical research by Reed College's Kimberly Clausing found "very little robust evidence linking corporate tax rates and wages." The consensus in the field remains that most of the tax is paid by capital (as Treasury and the CBO both assume).

Hassett's contentions, in other words, are well outside the mainstream of economics. But they rebut the two largest arguments against Trump's tax plan: the overwhelming cost of the package, and the fact that it offers little to nothing for middle-class families and a lot to the very rich. Hassett's research enables the White House to insist that the secret to unleashing middle-class wage growth is offering corporations massive tax cuts — and that they can do it in a way that raises revenue by stimulating economic growth.