A Bipartisan View of Tax Reform

Today’s political climate has rendered it incredibly difficult, perhaps even impossible, to foresee any type of bipartisan effort on government policy.  The already considerable structural limitations present in the House of Representatives and Senate have been further exacerbated by ever-increasing political polarization, and attempts at law-making appear to be driven by the staunch political agendas of each party more so than ever before.  Wherever your fundamental beliefs lie on the political spectrum, it is hard to disagree with the notion that the unsavory combat on Capitol Hill has become more and more characterized by the idea that party members are either “with us or against us” on both sides of the aisle. Moderates don’t seem to have a place in today’s arena, and if they do truly exist, the fear of being ostracized has ensured that they will not speak up often. Historically, bipartisanship has thrived in the field of tax reform. Call it what you want, but fiscal policy has long been the hallmark of campaign promises, and has often been the driving factor during both times of economic peril and prosperity. Agreement on the double-edged sword that is fiscal policy requires compromise from both ends of the political spectrum founded by mutual respect for values of economic freedom and equality, and a government willing to embrace collaboration. Perhaps it is a romanticized thing of the past, a dream of the naïve. In the grand scheme of things however, the responsibility of government to enact fiscal policy is undeniable irrespective of political platform. Increasing tax revenue, encouraging certain forms of economic behavior, and redistributing wealth are all essential for any viable tax legislation.

Then and Now

The adoption of President Reagan’s Tax Reform Act of 1986 into law was heralded by many as a bipartisan success. The effort was centered around lowering the rate and broadening the base. For individual income tax purposes, broadening the base refers to increasing the percentage of an individual’s income that is subject to taxation. However, the motivation for tax reform in the 80’s came from a phenomenon that was similar to President Trump’s situation; America’s corporate tax rate was higher than many of the other thriving developed nations. Additionally, the need for a simple tax code was becoming continually important at the time. In 1986, the Reagan Administration threw the first punch, bringing the Federal Statutory Rate down from 45 percent to 34 percent.

At the time, the 1986 Tax Reform Act provided the American economy with a massive jolt in the interim, and for better or for worse, it resulted in massive waves of deregulation that provided operational and regulatory flexibility for companies to function. In hindsight, it has become evident that prolonged waves of deregulation will hinder long term economic growth. The net effect of the base-broadening measures discouraged savings and investment for American households, which eventually led to the Savings and Loan Crisis. Consequently, certain parameters of the reform in ’86 resulted in a negative impact to Gross Domestic Product (GDP).

President Trump’s recent fiscal policy enactment is certainly a change in the direction of how the United States hopes to create and sustain its economic ecosystem. In line with the notion that “America is open for business”, this tax cut has the opportunity to stimulate growth, reinvestment, and increase wages on a national level. However, it is vital that we are cognizant of the long-term ramifications of this type of evolution in tax legislation, as those who forget history are doomed to repeat it.

International Reaction (Race to the Bottom)

In socio-economic terms, a race to the bottom refers to the trend of rapid deregulation and lowering of tax rates across developed nations in an effort to attract business activity from corporations across the world. This has largely stemmed from the initial Statutory Tax Rate cut in 1986 and has continued ever since. At a glance, this means that downward pressure is increasing on tax rates globally.

The Tax Cuts and Jobs Act of 2017 has almost immediately attracted the attention of global companies to the U.S. The United States has already transitioned from the nation with the highest statutory rate to the country with the fourth lowest among the G20. That type of change in position plays well to the United States’ economic outlook on the basis of international investment and job creation. Companies who have traditionally operated in European nations now have a viable interest in relocating their operations to the United States. While tax havens still exist elsewhere for particularly frugal corporations, the United Sates now offers an opportunity that provides both scalability and a very lean corporate tax rate. Additional value is added through stability, consistency, and ingenuity, as the argument can be made that other developed countries simply do not have as much to offer in these regards as the United States does. Stronger capital and consumer markets, strong infrastructure, and an anticipated rise in the value of the U.S.D all favor the United States’ fortune as the country brands itself as “open for business.” European nations which have historically used fiscal policy as a tool to compete against the United States are now in a precarious position and must carefully assess how to proceed.

Are we all really winners?

In theory, this tax cut should have a far reaching positive impact across the country. Several economic models predict that corporations, especially financial institutions who are set to benefit considerably from the new rates, will have the opportunity to re-invest significantly greater sums of capital with the adjustment to their after-tax earnings. With that being said, we must understand that economic models are nothing more than models that control for certain variables based on preconceived notions of growth and other theoretical assumptions. To be perfectly clear however, this tax cut is not revenue neutral. If it were, people would pay lower taxes based on their total income. Instead, this tax cut ensures almost everyone will pay less.

Anytime there is a reduction in the cost of capital, there is strong evidence to suggest that there will be some form of economic growth and subsequent reinvestment. In recent weeks, several companies have already announced their plans for infrastructure projects, intentions to increase wages and bonuses, and proposals for overall expansion. Theoretically, this bill was expected to lower taxes, give companies more leeway with after-tax earnings, increase profits, and as a result encourage increased investment back into the national economy. Would these companies have done any of this without the tax bill? It is impossible to say for certain, but recent headlines have suggested that this is all attributable to tax reform.

Uncertainty and Stipulations on the Horizon

The Trump administration has made it abundantly clear that the private sector, through supply-side economics, is responsible for creating wealth. Lowering tax rates instead of trying to stimulate particular sectors of the economy seems to be the tool the Republicans are determined to use. One major question still remains: will every company pay the 21 percent? The answer is likely not. With so many different provisions for different companies, it’s unclear how this policy shift will affect the overall effective rate, and thus how much tax some companies will really end up paying. Regulatory bodies like Financial Accounting Standards Board (FASB) are largely unsure of how this legislation will affect and impact the bottom line of companies’ earnings and income tax expenses.

This tax cut has essentially promised to inject significant value into the economy at the cost of running a deficit. This could prove to be particularly detrimental if assumptions on projected economic growth do not come to fruition. One of the popular themes of this reform was the idea that average household income would go up by $4,000, which was a consistent narrative used by the White House Council of Economic Advisers. That $4,000 figure is actually nothing more than an estimate of the impact of the policy itself, and it is expected to occur in about eight years. It is also dependent on an increase in corporate capital investment and GDP growth accelerating to an aggressive rate between three percent and five percent. Most importantly, and reminiscent of the 1986 reform, it is abundantly unclear if these tax advantages for corporations will really trickle down to job creation and salary benefits for the working class.

As is the case with any sweeping policy change, much of the effects of this tax reform won’t be felt for at least another few years. The rhetoric around Tax Reform has gone from exceedingly hostile to slightly more constructive. In the interim, with Trump seeming to soften his tone on immigration and beginning to shift his focus on infrastructure projects, the case can be made that the Republican Party might emerge from the midterm elections unscathed if there is a significant economic jolt within the year. While the advantages in the short-run will likely benefit the Republican agenda, continued conversation on managing the threat of long-run economic hardship is equally important. With that, bipartisanship will become vital to government as it attempts to legislate for the greater good of the country. As Alan Greenspan once alluded to, it is imperative that we are weary of irrational exuberance, and continue to battle for policy and legislation that adhere to the notions economic freedom and equality.

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