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Donald Trump's trickle-down delusion on taxes

President Donald Trump delivers remarks on proposed changes to the U.S. tax code at the state fairgrounds in Indianapolis, Indiana, September 27, 2017.
Jonathan Ernst | Reuters
President Donald Trump delivers remarks on proposed changes to the U.S. tax code at the state fairgrounds in Indianapolis, Indiana, September 27, 2017.

If there were still any doubt that President Donald Trump is a trickle-down economics guy rather than a populist, consider his new tax plan. It would represent the largest set of cuts since the era of George W Bush. The Business Roundtable and other executive organisations that support Mr Trump's plan argue, correctly, that US corporate rates are far higher than the average among the OECD group of wealthy nations, and that the US desperately needs a simpler, more streamlined tax code to avoid losing cross-border assets.

They also argue that slashing corporate rates will dramatically boost American growth, bring back jobs and raise wages. That's a tougher sell. For one thing, tax cuts have not spurred sustained growth for 20 years. Yes, there were tax cuts and growth during the Reagan era. There was also higher productivity growth, women entering the workforce en masse and a federal debt burden of 20 per cent of gross domestic product.

Today, debt is 77 per cent of GDP, productivity is flat and, not only have the major gains from female participation in the labour force been realised, but birth rates are lower, and the president is doing the best he can to limit immigration. Growth equals productivity plus demographics. Game over, unless something in that equation changes.

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Shifting assets to places with lower taxes is one thing. Creating real economic growth is another. Business leaders sometimes confuse the two. Perhaps some of them believe that one will lead to the other. But if you survey the economic landscape, it's not like there isn't plenty of money sloshing around. Dealmaking, asset values and corporate debt are at record highs. The money is there. The jobs are not.

"The US has political problems, as well as issues of the slower growth of any developed country. Yet we pretend that we can finesse all this away with a lower corporate tax rate."

I would argue that this is because there is not enough consumer demand. As one emerging market chief executive recently said, he has "given up" on growth in the US, since most demand comes from abroad. In an economy in which consumer spending accounts for roughly 70 per cent of GDP, it is a bit of a problem when it is not maintained at the necessary level. Average Americans have not had a pay rise in real terms since the early 1990s.

Corporate leaders will say: cut taxes, let us bring back our $2.6tn overseas cash hoard on the cheap and we will create jobs and demand. I wish I could believe that. But that would mean ignoring the historical evidence that repatriation tends to be funnelled to shareholders rather than workers.

While many business leaders want to believe that creating growth is as easy as cutting corporate taxes, there is a much deeper issue at play on the private sector side: who companies are run for and how they are run.

A persuasive paper published by the left-leaning Institute for New Economic Thinking argues that our framework for corporate governance is wrong. American companies, and to a lesser extent British ones, are run according to "agency theory", which holds that shareholders drive corporate performance and economic growth by their investment. It follows from this that they are entitled to any spare cash the company generates.

The idea is that this is a virtuous and productive cycle in which capital is allocated wisely and fairly. It is the argument that corporate "activists" will use to justify themselves as creative destroyers and rebuilders of value, rather than barbarians at the gate. Yet any uptick in the performance of companies targeted in this way can just as easily be explained by increasing profits through cost-cutting and lay-offs as by improving corporate performance.

Meanwhile, there is a growing imbalance between those who create value in the economy (not only executives and some investors but workers and taxpayers through their investment in for example education and basic infrastructure) and those who can extract it — mainly shareholders, who have been given record payouts in the past through share buybacks and dividends.

The most dramatic example is Apple, which from 2012 to 2017 spent $151bn on buybacks and $54bn on dividends under its capital return programme. Yet the only time in its history that Apple ever raised funds on the public markets was in 1980, when it collected $97m in its initial public offering. As economist William Lazonick, author of the INET paper, rightly asks: "How can a corporation return capital to parties that never supplied it with capital?" It can, obviously, but we should not assume that such a system will magically increase growth. Twenty per cent of the population owns 80 per cent of the stock, and there are only so many houses and cars and pairs of jeans they can buy.

This wilful blindness to dysfunction in our market system is what is worrying about the corporate tax debate. The US has political problems, as well as issues of the slower growth of any developed country. Yet we pretend that we can finesse all this away with a lower corporate tax rate.

Sure, we can cut taxes. But it will not change the fact that we have a private sector market system that no longer serves the real economy. Business leaders who care about long-term growth and competitiveness need to think hard about how to fix that, and stop kidding themselves that a trickle-down tax plan is the answer.

More from the Financial Times:
A lost chance for reform of US corporate taxes
Charts that matter: US corporate bond spreads squeezed by tax reform plan
Corporate bond demand sends index to 10-year record

Commentary by Rana Foroohar, a global business columnist & associate editor at Financial Times. Follow her on Twitter @RanaForoohar.