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The real stakes in the tax reform debate

President Donald Trump speaks about tax reform in Harrisburg, Pennsylvania, U.S., October 11, 2017.
Joshua Roberts | Reuters
President Donald Trump speaks about tax reform in Harrisburg, Pennsylvania, U.S., October 11, 2017.

The debate over "tax reform" has, by design, a kind of bloodless technocratic sound to it. But lurking behind the euphemism and the sometimes-arcane details is a big debate about inequality, political power, and the nature of economic growth.

It's no accident that by 2016 the richest 1 percent of the population had earned 24 percent of the income and held 39 percent of wealth or that household incomes at the middle are flat and living standards for the poor or falling. A new wave of research builds a persuasive case that tax cuts passed in the 1980s and 2000s were key drivers of this disparity.

Donald Trump and Congressional Republicans are promising another round of similar policies and they want to get it done soon. They firmly believe that tax cuts for the very rich will be a boon to the whole economy. They also know cutting taxes on the rich is unpopular, so they've cloaked their case in descriptions of "simplicity," "fairness" and denying the premise outright.

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But a tax agenda focused on corporate rate cuts, special tax breaks for businesses owners, estate tax repeal, and a reduction in the top marginal rate can't help but make the rich richer — and a new breed of economic research, spurred by Thomas Piketty's work but now joined by many collaborators, challenges the premises of the tax cutting drive, arguing that this kind of policymaking exacerbates pretax inequality while doing nothing for economic growth.

Democrats have grown more critical of inequality in recent years with Barack Obama proclaiming economic inequality to be the "defining challenge of our time." Energy in the party shifted even-further-left and fueled an unexpected level of support for Bernie Sanders and an unprecedented level of skepticism about the basic fundraising model of American politics.

Even more surprisingly, in the GOP camp Donald Trump ran hard to the right on culture war issues while also promising a more egalitarian form of economics — promising to be a champion of working class interests.

But in office, while Trump has continued to obsessively feed the culture war maw, he is pushing a policy agenda that would add enormous fuel to the fire of inequality — enormous, regressive rate cuts flying under the banner of "tax reform."

Tax policy is a major driver of inequality

Redistribution went out of fashion in the 1980s. In the evocative phrase of Arthur Olson, It was a "leaky bucket" — transferring some money from the haves to the have-nots would reduce the total amount of money to go around. As long as economic growth was strong, as it was in the 1950s and 1960s, a hefty dose of redistribution seemed like a reasonable and humane policy.

But after the economic troubles of the 1970s, Ronald Reagan (and Margaret Thatcher in the UK) brought a new school of thought to town.

As Reagan himself put it in 1986, "one of the prime motivating intentions of this administration was to get the economy going again. And it was clear the way to do that was cut tax rates, stop penalizing initiative, and sit back and watch the fireworks." No more leaky buckets. Instead, the rising tide of growth would lift all boats.

Three or four decades later, scholars are able to look at the fruits of those policies and draw some conclusions. The same main technologies that exist in the United States and United Kingdom are also in use in Germany and Sweden. Those countries are also exposed to the forces of global trade and immigration. But inequality has grown much more sharply in the US and UK than it has in Germany and Sweden. And the main reason seems to be taxes.

Looking across the world in a series of papers, a line of academic research originally pioneered by Piketty and Emanuel Saez joined over time by a growing list of other economists finds that falling marginal tax rates on the rich are strongly correlated with higher levels of income concentration but don't lead to faster overall economic growth.

The bucket, in other words, isn't leaky after all. And though inequality is surely shaped by big forces like digital technology and globalization, it appears to be more profoundly shaped by tax policy.

Lower taxes on the rich straightforwardly engender inequality by giving rich people more money. But they also shift incentives. In the old days of 70 or even 90 percent marginal tax rates, it wouldn't make much sense for executives to expend enormous amounts of time and energy trying to maximize the amount of money they can personally extract from a company in the form of salary. Instead, you might chase social prestige or other goals. And last but by no means least, tax cuts on investment income increase the extent to which wealth can mechanically beget more wealth as financial assets inherited from or gifted by parents simply earn their natural rate of return over time.

Instead of a rising tide lifting all boats, most families are left high and dry as the wealthy suck up a larger and larger share of an overall pool of money that isn't growing very rapidly.

But while this new series of literature has gained a lot of adherents in recent years, the acclaim has hardly been universal. And last week, the Trump administration, through a report by its Council of Economic Advisors, firmly planted its flag on the other side of the argument.

The Trump tax report is crucial because it's honest

Kevin Hassett, head of the White House Council of Economic Advisers, released a report last week touting the benefits of a steep cut in the corporate income tax rate that serves as one of the most significant policy developments of the year. It features a well-qualified economic policy team articulating what it is that right-of-center economists actually think about tax policy.

Cutting taxes for the rich has become unpopular, so Republicans have begun to adopt a range of obfuscatory strategies to deny that this is what they are doing. In mid-September, Trump vowed that his tax plan would not help rich people "at all," echoing a pledge made in January by Treasury Secretary Steve Mnuchin to avoid delivering any "absolute tax cut" to the wealthy.

More recently, Mnuchin has backed off that pledge by pleading mathematics just makes it hard to not cut people's taxes. "The math, given how much you are collecting," he told Politico's Ben White "is just hard to do."

The truth is that it's not hard at all. Republicans are proposing tax cuts for the rich because they think cutting taxes on the rich is a good idea. The CEA report is significant for saying so, relatively plainly, albeit in the specific context of discussing the merits of a cut in the corporate income tax rate. Corporations are owned and managed by people, so in the first instance a corporate tax cut goes to benefit the rich people who own the companies and the rich executives who compensation packages are tied to the share prices.

But to Hassett that's not the whole story. A corporate tax cut makes America friendlier to the global investment community, and that, he says, ultimately serves to boost middle-class wages:

The deteriorating relationship between wages of American workers and U.S. corporate profits reflects the state of international tax competition. The problem is not unique to America; countries around the world have responded to the international flow of capital by cutting their corporate tax rates to attract capital back from other countries. They have doubled down on such policies as they have seen business-friendly policies benefit workers.

The theoretical modeling behind Hassett's later calculations is complicated, but this basic intuition is familiar. When Amazon announced that it wants to build a massive second North American headquarters, a dozen or more cities unveiled plans to dole out various forms of tax subsidies hoping to attract the investment.

Hassett's contention, in essence, is that the best way to benefit the American worker is to engage in a global version of this subsidy game. Instead of targeted subsidies for new investments from one particular company, he and Trump want to offer a broad subsidy to allinvestment profits — old profits and new profits, real returns on productive investments and returns on monopoly rents — in the hopes of maximally catering to investor interests. By catering to the interests of the global investor class in this way, he thinks, we can do so much to boost the growth of the American economy that almost everyone will end up better off.

Hassett's view is broadly shared on the right

Hassett's style of argumentation has been challenged by a new breed of inequality researchers in recent years. But it remains a reasonably popular one in the economics profession with a decent number of well-qualified and well-credentialed proponents.

Greg Mankiw, who held Hassett's job under George W. Bush, has, for example, proposed eliminating the corporate income tax entirely and replacing it with a kind of national sales tax. Mankiw is also a longtime proponent of eliminating all taxation of rich people's estates, another very concrete objective of the Republican tax framework. Doug Holtz-Eakin, a well-regarded former Congressional Budget Office director and current think tank leader, believes that eliminating the estate tax will create lots of jobs.

Estate tax repeal, by definition, only helps a tiny number of families directly. But as a pure tax on wealth, it's also by definition very investor-unfriendly. And conservatives very sincerely believe that adopting more investor-friendly policies will benefit everyone in the long run. Republican elected officials rarely put it that way on the campaign trail because they rightly think most people disagree with them. But it's the premise underlying their policies, and it's what the policy experts they count on think is true. There's no new populist alternative to Reagan-style trickle-down — there's a culture war overlay and the stubborn belief that cutting rich people's taxes will spark enormous growth.

Trickle down, not "economic nationalism" is the real Trumponomics

The policy approach that Republicans recommend — bending over backward to appeal to the needs of rich global financiers in the hopes that they will bless us with some investment — probably makes sense for some countries.

Hassett's precise calculations are based in part on the reality that a number of post-communist Eastern and Central European countries appear to have successfully implemented a strategy along these lines.

It's worth saying this is the precise opposite of the bold "America First" sloganeering that Trump likes to deploy.

And there's very good reason to doubt that it's applicable to the United States of America. Fundamentally, we are not a relatively small, relatively poor country existing on the European fringe and hoping to pick up a German-owned factory or two to narrow the income gap with our wealthier neighbors. We are an enormous, wealthy country whose greatest companies — many of whom, incidentally, are located in relatively high-tax coastal jurisdictions — push the frontiers of human knowledge and technical expertise forward.

We're also a country that right now is enjoying really low interest rates. Ultra-safe Treasury bond yields are low, but so are risky "junk" bond yields. The stock market, as Trump himself keeps saying, is at a record high.

What American lacks, as Trump himself used to say on the campaign trail, is a reasonable distribution of economic resources, world-class infrastructure, affordable health care, and affordable child care. Investing resources in creating the things Trump said he would create, rather than in kowtowing to the transnational financial elites he said he was fighting, would improve middle-class people's lives in a direct and tangible way.

But rather than craft policies to do any of that, Trumpism is proving to be an enormous bait-and-switch whose strategy for boosting the economy is to recapitulate George W. Bush's agenda of cutting taxes for the rich and hoping for the best.

The stakes are enormous

The stakes in the Republican effort to repeal and replace the Affordable Care Act were massive and obvious. Republicans were proposing revisions to programs that directly insure millions of people and that indirectly regulate the health insurance used by tens of millions more.

Citizens were interested in basic, obvious questions about it: Will my insurance get better or worse? Will I pay more or less for it? The repeal effort eventually failed in part because the answers — mostly higher prices for mostly worse insurance — were so unsatisfactory.

The stakes in delivering big tax cuts to corporations and investors could be equally plain if, ultimately, Republicans decided to fully offset their cost by raising other taxes or cutting spending on government programs. But it seems much more likely that tax cuts will, ultimately, end up being financed by a mix of new borrowing and wishful thinking on economic growth just the way Reagan and Bush did it.

In that case, the budget deficit naturally becomes an opposition talking point. But the real stakes are both larger and more abstract. The tax debate is, fundamentally, a debate about the rules of the economy and who they are meant to serve.

The theory that structuring economic policy to cater to the whims of financial elites will boost growth may or may not be true, but doing it unquestionable funnels more money into the pockets of the donor class that drives Republican tax policy. Economic inequality begets political inequality which begets more economic inequality and so on and so forth down the chain.

But the public's view on this is clear. Voters want the rich to pay higher taxes and voters want big corporations to pay higher taxes. Republicans want the opposite, which is why Trump often says his plan won't cut taxes for the rich and why his Treasury secretary is acting as if a tax cut for the rich is just some unavoidable mathematical fact. The CEA paper is, by contrast, a useful clarifying moment. The administration believes that more inequality is simply the best way forward on the merits.

The question is whether they're going to get their way.