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Missteps Undermine the Legacy of the 2017 Tax Cuts

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Missteps Undermine the Legacy of the 2017 Tax Cuts

November 18, 2019

The disappointing third-quarter economic data—showing a 1.9% economic growth rate and declining business investment—has brought another round of commentary that the 2017 Tax Cuts and Jobs Act (TCJA) has failed to deliver on its promise. Opinion articles such as “The GOP Tax Cuts Didn’t Work,” and “The Republican Tax Cut Is a Big, Fat Failure” reflect this increasing conventional wisdom.

The economy has certainly failed to achieve the consistent 3% growth rates promised by President Trump. Yet the economy’s overall performance remains healthy. The 3.5% unemployment rate is the lowest in 50 years, and the recent slowdown in job growth reflects the lack of remaining unemployed people to move into jobs. This low unemployment rate has also pushed annual wage growth up past 3%, with wages now growing the fastest for the bottom-half of earners as well as for non-whites. The continued economic expansion is now the longest in American history, and the S&P 500 has soared by 34% since January 2017, due in part to both the anticipation and delivery of tax relief. Even worker productivity growth—the most important driver of long-term prosperity—is finally on an upswing. Overall, 52% of Americans rate the economy as “good” or “excellent, versus just 13% calling it “poor.”

Expert opinions are split on the wisdom of the tax reforms, and their contribution to the economy’s continued (albeit modest) growth. However, to the extent that the TCJA provides significant benefits, its advocates in the White House, Congress, and elsewhere have undermined any credit the tax relief could receive with several missteps. Indeed, a plurality of Americans continue to disapprove of the 2017 law. The long-term danger is that—even if the tax cuts end up helping the economy—policymakers and voters will conclude otherwise, and react by pursuing more destructive policies. This undermining of the TCJA has come in five forms:

1. Overpromising the benefits. The Tax Foundation’s economic model—considered one of the more rosy models for TCJA-style reforms—projected that the law would increase annual economic growth rates by 0.3% for the first decade (from 1.8% to 2.1%), and raise long-term wages by 1.5%. However, President Trump promised growth rates of 3% (and previously promised as high as 6%), and the President’s Council of Economic Advisers declared that families should expect their household income to quickly begin rising by between $4,000 and $9,000. Allies in Congress asserted that tax reform would produce enough tax revenue growth to pay for themselves. Dismissing the time-tested strategy of under-promising and over-delivering, the White House and its allies created a standard for success that their tax reforms could not possibly meet.

A wiser approach—albeit a less exciting one—would have cautioned voters that the TCJA’s signature business tax cuts will take time to work through the economy and produce gains. The investment tax incentives require a business to: 1) institute a new investment plan; 2) purchase and install the new investments; 3) train workers to utilize the new plants and equipment; 4) wait for the increased productivity to result; and 5) translate this productivity into worker wage gains. This timeframe can take years, even though it is the surest path to long-term prosperity and wage growth. Additionally, the complexity of the business tax provisions, as well as the short-term business costs such as the “toll charge” for multinational companies, have further delayed the promised surge in new investment. Rhetoric aside, the TCJA was not designed as an immediate stimulus, but rather a long-term investment in a stronger economy. Advocates should have emphasized that.

2. Sabotaging the economy with tariffs. TCJA advocates told voters to expect more economic growth, wage gains, and job growth. Then President Trump imposed tariffs that have offset 40% of the TCJA’s positive economic growth, and may offset more than 100% of its job gains. The tariffs’ $831 cost to middle-income earners has offset more than 90% of their tax relief savings. Few voters will make a distinction between the TCJA and tariffs in regards to their family finances, and instead most have understandably concluded that their family received no tax relief.

3. Setting up the tax cuts to be blamed for all budget deficits. Even before the TCJA was enacted, deepening Social Security and Medicare shortfalls were projected by the nonpartisan Congressional Budget Office to increase the budget deficit from $665 billion to nearly $1.5 trillion by 2027. Subsequent tax relief and the recent discretionary spending increases have each added approximately $240 billion to the 2027 deficit projection. In other words, the TCJA is responsible for roughly one-fifth of the rising deficit projected over that decade.

However, enacting $240 billion in annual tax cuts without paying for them will continue to make it easy for critics and the media to tie the entire rising red ink to the TCJA, simply because it happened to be the most high-profile, deficit-financed bill enacted recently. By contrast, the growing Social Security and Medicare shortfalls driving most of the 10-year deficit rise are easily ignored because they occur automatically with no congressional votes. The discretionary spending increases were seen as less controversial, and are thus often forgotten in deficit discussions. Paying for tax reform would have shielded it from blame over the already-rising deficit, and focused lawmakers on addressing the dominant deficit drivers.

4. Eliminating the constituency for income tax relief. Conservative lawmakers have been so sensitive to accusations of cutting taxes only for the rich, that they have essentially eliminated income taxes for the bottom half of tax filers. Between 1981 and 2016, the average federal income tax rate fell from 0.4% to -10.9% for the bottom quintile of earners, 4.9% to -1.2% for the second quintile, 8.2% to 3.1% for the middle quintile, and 11.0% to 6.7% for the fourth quintile (the top quintile has seen the smallest decline, from 16.7% to 16.0%). The refundable Earned Income Tax Credit and child tax credit—both championed by Republicans—have created many of these negative income tax rates. As a result of these policies, middle- and lower-income families paid so little in income taxes by 2017 that additional income tax relief was not a priority for them. Furthermore, even the 2017 approach of cutting taxes roughly in proportion to a family’s current income tax burden was easily attacked as a tax cut for the rich, because at that point the top quintile was paying 87% of all federal income taxes. Payroll tax relief would have affected more families, although that would have worsened Social Security and Medicare’s shortfalls and may not have provided much economic growth.

5. Timing the tax cuts at the end of a boom. By the time the TCJA was implemented in early 2018, the economy was already 8.5 years into what would become the longest economic expansion in American history, and at a point where a recession would be expected to occur within a year or two. Thus, even if tax reforms maintain the previous 2% economic growth rate, they will likely be criticized as a “do-nothing” tax cut rather than credited for averting a recession. This is the flip side of the 2009 stimulus law, the vast majority of which was implemented after the economy had naturally emerged from recession in July 2009, yet was still given credit by many for the (weak) recovery. Politically, it is better to implement a new economic policy during the beginning of a natural economic upswing (and then claim credit), rather than the beginning of a natural downswing (where the policy will be blamed for a decline, or at least not given credit for averting the decline). Granted, this variable does not reflect a misstep as much as unfortunate timing.

All tax relief laws inevitably face two public opinion challenges that cannot be blamed on their advocates. First, surveys have longed showed public skepticism of tax cuts (and even many spending increases) based on a voter perception that somehow they will be left out of the law’s benefits. Indeed, surveys following past tax cuts have long shown that most respondents refuse to believe that their taxes have been reduced—even when the policy is universal, and regardless of which party enacted the policy. The second challenge is partisanship. A new survey shows that those who consume conservative media have a much rosier view of the economy than those who consume liberal media—and under a previous Democratic presidency, the public economic perceptions were flipped. Opinions on tax policy are also surely seen through a partisan lens.

None of this suggests that the TCJA reforms were flawless or even a net positive (I graded the law a B- when enacted), or attempts to explain away the subsequent economic performance. Rather, the point is that regardless of whether the law ultimately helps the economy or not, its advocates have inadvertently undermined the public perception of the TCJA (and tax reform in general) with several missteps and some bad timing. However successful (or unsuccessful) the law ultimately becomes, the long-term public perception will likely be more negative than if advocates had not made the mistakes detailed above.

The reality is that it is simply too early to tell if the TCJA will ultimately raise economic growth, push up wages, and create jobs. Businesses are still planning investments, interpreting the law’s complexities, and paying the international toll charge. Investments take years to produce wage gains. Uncertainty over the TCJA’s scheduled expirations as well as politician promises to repeal the law are surely causing some businesses to take a wait-and-see approach. Economists spent 30 years debating the effects of the 1986 tax reforms, and many still have not caught up to the strong positive effects of the 2003 tax cuts (which were eventually covered up by the unrelated 2007 housing crash). It will take several years to adequately analyze the 2017 tax reforms.

Brian Riedl is a senior fellow at the Manhattan Institute. Follow him on Twitter @Brian_Riedl.

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